ALZA Corporation develops, manufactures, and markets therapeutic products that incorporate drugs into advanced dosage forms designed to provide controlled, predetermined rates of drug release for extended time periods. ALZA may be best known for its Nicoderm nicotine transdermal system. It reported the following liabilities in its 1994 and 1993 balance sheet:
1994
1993
(Dollars in thousands)
Liabilities
Short term debt
$ —
$249,520
Accounts payable
20,006
11,678
Accrued liabilities
18,773
17,415
Deferred revenue
16,340
6,698
Current portion of long term debt
869
867
Total current liabilities
$ 55,988
$286,178
51/4% zero coupon convertible
subordinated debentures
$344,593
$ —
Other long term liabilities
41,192
28,969
Total long term liabilities
$385,785
$ 28,969
Required
a. Identify and describe any unfamiliar terms in ALZA’s balance sheet (excerpts).
b. What strategic decision did ALZA implement in 1994? How do you know this?
c. Describe how this decision will affect ALZA’s current ratio. How are its capital composition ratios affected?
d. Should ALZA’s investors or creditors be unduly concerned about the decision of part b? Why?
e. ALZA’s net income for 1994 and 1993, respectively, was $58,120,000 and $45,612,000. The “fine print” at the bottom of the financial highlights indicated that ALZA’s 1993 net income includes “a $3.8 million ($.05 per share) extraordinary charge relating to the redemption of ALZA’s 51/4% zero coupon convertible subordinated debentures.” How does this new information change your conclusions regarding ALZA’s decision (see part b)?
f. How would your conclusions differ if ALZA’s net income had only been $5 million each year?
Tall Tree Timber, Inc., issued $10 million in long term bonds that contained the following restrictive covenants:
• Current ratio must exceed 2.0.
• Return on assets must exceed 2%.
• Net income ratio must exceed 2%.
• Debt composition ratio must be less than 60%.
Tall Tree Timber’s most recent financial results (dollars in millions) follow:
Current assets
$ 40
Current liabilities
$ 10
Property, plant, and equipment
55
Long term debt
9
Other assets
10
Stockholders’ equity
86
Total assets
$105
Total liabilities
and stockholders’ equity
$105
Net revenues
$600
Income tax rate
20%
Net income
$ 30
Interest expense
$ 5
Required
a. Compute the appropriate ratios described in the loan covenants and evaluate whether they have been met. Use ending total assets for average total assets.
b. Suppose the auditors find that revenues have been overstated by $38 million, thereby reducing revenues and reducing net income by $28 million net of tax. This new calculation will reduce stockholders’ equity and current assets by $28 million. Recalculate the appropriate ratios and test whether the loan covenants have been met.
c. Alternatively, suppose Tall Tree changes its depletion allowance calculations (of natural trees). This new calculation will reduce stockholders’ equity (net income) and property, plant, and equipment by $50 million. Again, recalculate the appropriate ratios and test whether the loan covenants have been met.
d. Alternatively, suppose Tall Tree Timber decides to switch from FIFO to LIFO and that such a switch will reduce current assets and stockholders’ equity (net income) by $30 million. Again, recalculate the appropriate ratios and test whether the loan covenants have been met.
e. Which of the above scenarios would cause the greatest concern to bondholders? Would any of these likely result in default proceedings to redeem or “call” the bonds? Why?
Calculating Bond Premium (or Discount) and Refinancing
Tall Tree Timber issued $10 million in bonds with a nominal interest rate of 8%, at a time when the market rate for similar bonds was 4%. The bonds have a fouryear maturity and pay interest semiannually.
Required
a. Calculate the premium or discount on the issue date. Indicate how the bonds would be shown on Tall Tree Timber’s balance sheet on the date of issue.
b. Calculate the interest expense and the cash outflows that would occur at the end of each semiannual period.
c. Tall Tree Timber anticipates refinancing the bonds at the end of the second year, in other words, after four semiannual periods have expired. To do so, it would issue $10 million of new 5% bonds at par. The firm has sufficient operating resources to pay for any other redemption costs, including the call premium of 2% over par.
i. Calculate the cash flows associated with refinancing or refunding the old bonds. Also calculate the gain or loss to be recognized.
ii. Evaluate whether the proposed refunding is advantageous for the firm’s shareholders? Why?
d. Discuss the advantages and disadvantages of a GAAP requirement that all long term debt must be shown at its current market value, rather than at its market value only on the issue date.
Analyzing Long Term Debt and Calculating Appropriate Ratios
Retrieve the most recent 10 K filings for Kmart, Wal Mart, Gillette, and Mem Co. from the EDGAR archives (www.sec.gov/edaux/searches ). Examine the long term debt section of the Notes to the Financial Statements:
Required
a. Calculate the ratio of long term debt to total assets for each company for the last two years. Comment on any changes that you observe.
b. Analyze the long term debt for each company, using the following format:
Term to Maturity
Interest Rates (Range)
Due within one year
Due in two years
Due in three years
Due in four years
Due in five years and beyond
c. Compare Kmart to Wal Mart. Which company obtained better terms from its lenders? Why?
d. Compare Gillette to Mem. Which company obtained better terms from its lenders? Why?
Review the balance sheet to determine how and where deferred taxes were reported.
Required
a. Read Note 6, “Income Taxes.” Identify and discuss any unusual terms. Also trace disclosures of deferred taxes in the notes to corresponding disclosures in the financial statements.
b. Determine whether Wendy’s has a net long term deferred tax liability. If it is not a liability, determine what it is and how Wendy’s managers might view the income tax carry forward.
c. Identify the years where Wendy’s income taxes paid (shown at the bottom of the cash flow statement) as a percentage of income before tax was close to the statutory rate. Identify the years where Wendy’s paid less. Did it ever pay more than the overall statutory rate?
d. Discuss any other unusual concerns regarding Wendy’s deferred taxes. What other related information might an external analyst prefer?
Review the balance sheet to determine how and where deferred taxes were reported.
Required
a. Read Notes 1 and 14. Identify and discuss any unusual terms. Also trace disclosures of deferred taxes in the notes to corresponding disclosures in the financial statements.
b. Determine whether Reebok has a deferred tax liability. If it is not a liability, determine what it is and how Reebok’s managers might view its deferred income taxes.
c. Identify the years where Reebok’s income taxes paid (shown at the bottom of the cash flow statement) as a percentage of income before taxes was close to the statutory rate. Also identify any years where Reebok paid less. Did it ever pay more than the overall statutory rate?
d. Discuss any other unusual concerns regarding Reebok’s deferred taxes. What other related information might an external analyst prefer?
Selected information from the income statements and tax returns of Buchanan Trading Co. are provided below for 1999 and 2000, the firm’s first two years of operations (dollars in millions):
Selected Income
Selected Income
1999
2000
Income before depreciation and taxes
$1000
$1100
Depreciation expense
400
450
Pre tax income
600
650
Income tax expense (35%)
210
227.5
Selected Tax Items
1999
2000
Income before depreciation and taxes
$1000
$1100
Depreciation expense
700
800
Taxable income
300
300
Income tax payable (35%)
105
105
Required
Determine the following amounts:
a. Difference between the tax basis and book basis of Buchanan’s assets at the end of each year.
b. Deferred tax liabilities at the end of each year.
c. In the year 2001, Buchanan Trading Company reported $800 million of depreciation in its income statement and $600 million of depreciation on its tax return. The firm’s income before depreciation and income taxes was $950 million. Enacted income tax rates applicable to firms such as Buchanan were increased to 45% effective at the beginning of the year 2001. Based on this new information, determine Buchanan’s income tax expense and net income after tax reported on its income statement for the year 2001. Calculate the deferred tax liability reported on its balance sheet at December 31, 2001.
Tax Expense, Tax Payable, and Deferred Tax Liability:
Changing Tax Rate
During 2000, Wilbur Mills, Inc., recognized an additional $12 million of depreciation expense on its income statement and reported $16 million as depreciation on its tax return. During 2000, the statutory income tax rate was reduced from 40 to 35%, effective at the beginning of 2000. Pre tax income was $14 million.
Required
Determine the following amounts for 2000:
a. Income tax expense.
b. Income tax payable.
c. Difference between the book and tax bases of Wilbur Mills’ assets at year end.
d. Deferred tax liability at year end.
e. Percentage relationship between pre tax income and income tax expense reported in the income statement.
Tax Expense, Tax Payable, and Deferred Tax Liability:
Effects of Tax Rate Changes
Rosty Co. began operations in 2000. The firm recognized $30 million of depreciation expense on its income statement and reported $50 million as depreciation on its 2000 tax return. The firm’s income was taxed at 30%, and pre tax income was $25 million.
Required
Determine the following:
a. Tax liability.
b. Deferred tax liability at the end of the year.
c. Difference between the book and tax bases of Rosty’s assets at the end of the year.
d. Income tax expense.
e. During 2001, Rosty Co. recognized an additional $30 million of depreciation expense on its income statement and reported $40 million as depreciation on its tax return. During 2001, the statutory income tax rate applicable to firms such as Rosty Co. increased from 30 to 40%. Pre tax income in 2001 was $12 million. Determine the following amounts:
i. Difference between the book and tax bases of Rosty’s assets at the end of 2001.
ii. Deferred tax liability at the end of 2001.
iii. Tax liability for 2001.
iv. Income tax expense for 2001.
v. Percentage relationship between pre tax income and income tax expense reported in the 2001 income statement.
Gottlieb Enterprises is concerned about its balance sheet disclosures of deferred tax liabilities. Gottlieb’s preliminary balance sheet at the end of 2000 is summarized as:
Current assets
$ 400,000
Current liabilities
$ 250,000
Fixed assets, net
1,400,000
Long term debt
500,000
Total assets
$1,800,000
Shareholders’ equity
1,050,000
Total liabilities and
shareholders’ equity
$1,800,000
Gottlieb’s tax return shows that the net book value of its fixed assets for tax purposes is only $900,000.
Required
a. Based on the above information, compute Gottlieb’s deferred tax liability at the end of 2000, assuming a 38% average tax rate.
b. Assume that Gottlieb has already calculated a deferred tax liability of $250,000 at the beginning of 2000 and has included it erroneously in shareholders’ equity. Calculate the change in Gottlieb’s deferred tax liability.
c. Based on your answer in part b, indicate how Gottlieb’s income tax expense must have been affected by these tax deferrals.
d. Prepare Gottlieb’s corrected balance sheet at the end of 2000.
e. Discuss why it is important for a firm to disclose its deferred tax liabilities. To illustrate this importance, compare Gottlieb’s balance sheet shown earlier with the corrected balance sheet from part d.
Tyler Corporation’s statement of operations is summarized below (dollars in thousands):
2000
1999
1998
Net sales
$357,850
$282,403
$286,206
Costs and expenses:
Cost of sales
256,195
221,024
223,826
Selling, general, and
administrative expense
103,402
57,972
55,667
Interest expense, net
3,820
487
608
Total costs and expenses
363,417
279,483
280,101
Income (loss) before income tax (benefit)
(5,567)
2,920
6,105
Income tax (benefit)
Current
(859)
2,649
4,051
Deferred
(7)
(1,067)
(1,181)
(866)
1,582
2,870
Income (loss) before cumulative changes
(4,701)
1,338
3,235
Cumulative effect of changes in
accounting principles
(3,601)
Net income (loss)
$ (4,701)
$ (2,263)
$ 3,235
Required
1. Explain the item “Income tax (benefit).” How can income tax be positive?
That is, how can income tax be deducted from income before tax in 1998 and 1999, and added in 2000?
2. Calculate the following ratios for 2000 and 1999:
a. Operating income.
b. Net income.
c. ROE. Assume that average stockholders for 2000 and 1999 are $114,000 and $117,000 (dollars in thousands). Note: You may want to take out nonrecurring items before calculating the ratios.
3. Evaluate Tyler’s performance during 1999 and 2000.
The following information was reported by Pfizer, Inc., in its 1997 Financial Report:
(Dollars in millions)
Income before income taxes
$3,088
Provision (expense) for income tax
865
Income taxes paid currently
856
Deferred tax liabilities related to depreciating assets:
December 31,1996
253
December 31,1997
156
Required
Based on the information provided above,
a. Determine Pfizer’s effective income tax rate during 1997.
b. Determine the percentage relation between Pfizer’s actual tax payments and income before taxes during 1997.
c. Provide a likely reason for the difference between the percentages determined in parts a and b above.
d. Assume that Pfizer’s statutory tax rate is 32%. What would you estimate as the difference between the tax basis and the book basis of Pfizer’s depreciable assets at the end of 1996? at the end of 1997? What does this change during 1997 imply about the relative amounts of depreciation expense in Pfizer’s tax return and financial statements in 1997?
Sigma Designs’ statement of operations is summarized below (dollars in thousands):
1995
1994
1993
Net sales
$43,700
$ 34,989
$27,058
Costs and expenses:
Cost of sales
36,980
27,538
23,045
Restructuring charges
(517)
13,654
0
Sales and marketing
9,022
9,448
7,476
Research and development
4,349
11,988
5,043
General and administrative
3,521
2,718
1,951
Total cost and expenses
53,355
65,346
37,515
Income (loss) from operations
(9,655)
(30,357)
(10,457)
Interest income—net
336
699
1,207
Other net
546
(39)
(67)
Income (loss) before income taxes
(8,773)
(29,697)
(9,317)
Provision (credit) for income taxes
—
(151)
(2,151)
Net income (loss)
$(8,773)
$(29,546)
$(7,166)
Required
a. Explain the item “Provision (credit) for income taxes.”How can income taxes be positive? That is, how can income taxes be added to income?
b. How does this new interpretation about deferred taxes (see part a) affect your evaluation of Sigma Design’s profitability? Calculate relevant income statement ratios using both “bottom line” net income and any other income figures that you deem relevant. Be sure to calculate the net income ratio on an after tax basis. Calculate any other appropriate ratios and evaluate Sigma Design’s performance for 1995. Assume interest expense is $200 (dollars in thousands).
Interpreting Deferred Taxes
Sigma Designs’ statement of operations is summarized below (dollars in thousands):
1995
1994
1993
Net sales
$43,700
$ 34,989
$27,058
Costs and expenses:
Cost of sales
36,980
27,538
23,045
Restructuring charges
(517)
13,654
0
Sales and marketing
9,022
9,448
7,476
Research and development
4,349
11,988
5,043
General and administrative
3,521
2,718
1,951
Total cost and expenses
53,355
65,346
37,515
Income (loss) from operations
(9,655)
(30,357)
(10,457)
Interest income—net
336
699
1,207
Other net
546
(39)
(67)
Income (loss) before income taxes
(8,773)
(29,697)
(9,317)
Provision (credit) for income taxes
—
(151)
(2,151)
Net income (loss)
$(8,773)
$(29,546)
$(7,166)
Required
a. Explain the item “Provision (credit) for income taxes.”How can income taxes be positive? That is, how can income taxes be added to income?
b. How does this new interpretation about deferred taxes (see part a) affect your evaluation of Sigma Design’s profitability? Calculate relevant income statement ratios using both “bottom line” net income and any other income figures that you deem relevant. Be sure to calculate the net income ratio on an after tax basis. Calculate any other appropriate ratios and evaluate Sigma Design’s performance for 1995. Assume interest expense is $200 (dollars in thousands).
Waco Rubber Co. disclosed the following items in its 1999 financial statements:
1999
1998
Current assets
Deferred income tax benefit
$1,894,550
$4,139,205
Current liabilities
Deferred income taxes payable
—
236,543
Required
a. Discuss the nature of each of these deferred tax items. How should an analyst use these data?
b. Upon further examination of Waco’s notes to its financial statements, you find the following additional disclosures: On December 31, 1999, the Company had NOL [non operating loss carry forwards for federal income tax and financial reporting purposes of approximately $15,000,000 and $34,000,000, respectively, available to offset future taxable income. These carry forwards will expire at various dates between 2003 and 2000. Using a portion of both the federal income tax carry forward and the financial reporting loss is restricted, based upon the purchase price of two subsidiaries of the company. Based on this new information, reconsider the two items shown in Waco’s balance sheet. Why might they be so different? How much future benefit might really occur?
c. Upon further examination of Waco notes to its financial statements, you find no further disclosures or explanations of the above items shown on its balance sheet. In fact, the company only disclosed details relating to $338,000 of deferred tax provisions in 1999 and to $839,000 of deferred tax provisions (benefits) in 1998. What other information would you find helpful in order to analyze and interpret Waco’s financial statements?
RMN Corp. had a variety of shareholders’ equity transactions in 2000. It had the following balances in Shareholders’ Equity accounts and Cash and other assets accounts at the beginning of 2000:
Cash and other assets
$78,000,000
Common stock, $1.00 par value
5,000,000
Capital in excess of par
25,000,000
Retained earnings
50,000,000
Treasury stock (40,000 shares)
(2,000,000)
RMN had the following transactions that affected shareholders’ equity during 2000:
1. Issue five million shares of no par preferred stock at a price of $4.00.
2. Sell the treasury stock for $4,500,000.00.
3. Earn net income of $35,000,000.00.
4. Declare and pay dividends of $10,000,000.00.
5. Employee stock options were granted with the purchase of 100,000 shares of common stock. The market price is currently $7 per share. The exercise price is $7 per share.
6. The stock options were exercised and the company issued the 100,000 shares. The current market price is $8 per share.
Required:
Record these transactions in each of the components of shareholders’ equity and in Cash and other assets. Use the balance sheet equation to calculate the ending balance in each account.
The two following separate cases show the financial position of a parent company and its subsidiary company on November 30, 2011, just after the parent had purchased 90% of the subsidiary”s stock:
Case I
Case!!
P Company
S Company
P Company
S Company
Current assets
$ 880,000
$260,000
$ 780,000
$280,000
Investment in S Company
190,000
190,000
Long term assets
1,400,000
400,000
1,200,000
400,000
Other assets
90,000
40,000
70,000
70,000
Total
$2,560,000
$700,000
$2,240,000
$750,000
Current liabilities
$ 640,000
$270,000
$ 700,000
$260,000
Long term liabilities
850,000
290,000
920,000
270,000
Common stock
600,000
180,000
600,000
180,000
Retained earnings
470,000
(40,000)
20,000
40,000
Total
$2,560,000
$700,000
$2,240,000
$750,000
Required:
Prepare a November 30, 2011, consolidated balance sheet workpaper for each of the foregoing cases. In Case I, any difference between book value of equity and the value implied by the purchase price relates to subsidiary long term assets. In Case II, assume that any excess of book value over the value implied by purchase price is due to overvalued long term assets.
Assume that Company S”s balance sheet is the same as the balance sheet used in Case I (from part A). Suppose that there were 50,000 shares of S Company common stock outstanding and that Company P acquired 90% of the shares for $4.50 a share. Shortly after acquisition, the noncontrolling shares were selling for $4.25 a share. Prepare a computation and allocation of difference schedule considering this information.
On January 1, 2011, Perry Company purchased 8,000 shares of Soho Company”s common stock for $120,000. Immediately after the stock acquisition, the statements of financial position of Perry and Soho appeared as follows:
Assets
Perry
Soho
Cash
$ 39,000
$ 19,000
Accounts receivable
53,000
31,000
Inventory
42,000
25,000
Investment in Soho Company
120,000
Plant assets
160,000
110,500
Accumulated depreciation plant assets
(52,000)
(19,500)
Total
$362,000
$166,000
Liabilities and Owners” Equity
Current liabilities
$ 18,500
$ 26,000
Mortgage notes payable
40,000
Common stock, $10 par value
120,000
100,000
Other contributed capital
135,000
16,500
Retained earnings
48,500
23,500
Total
$362,000
$166,000
Required:
Calculate the percentage of Soho acquired by Perry Company. Prepare a schedule to compute the difference between book value of equity and the value implied by the purchase price. Any difference between the book value of equity and the value implied by the purchase price relates to subsidiary plant assets.
Prepare a consolidated balance sheet workpaper as of January 1, 2011.
Suppose instead that Perry acquired the 8,000 shares for $20 per share including a $5 per share control premium. Prepare a computation and allocation of difference schedule.
Intercompany Bond Holdings at Par, 90% Owned Subsidiary
Balance sheets for P Company and S Company on August 1, 2011, are as follows:
P Company
S Company
Cash
$165,500
$106,000
Receivables
366,000
126,000
Inventory
261,000
108,000
Investment in bonds
306,000
0
Investment in S Company stock
586,500
0
Plant and equipment (net)
573,000
320,000
Land
200,000
300,000
Total
$2,458,000
$960,000
Accounts payable
$ 174,000
$ 58,000
Accnted expenses
32,400
26,000
Bonds payable, 8%
0
200,000
Common stock
1,500,000
460,000
Other contributed capital
260,000
60,000
Retained earnings
491,600
156,000
Total
$2,458,000
$960,000
Required:
Prepare a workpaper for a consolidated balance sheet for P Company and its subsidiary on August 1, 2011, taking into consideration the following:
P Company acquired 90% of the outstanding common stock of S Company on August 1, 2011, for a cash payment of $586,500.
Included in the Investment in Bonds account are $40,000 par value of S Company bonds payable that were purchased at par by P Company in 2002. The bonds pay interest on April 30 and October 31. S Company has appropriately accrued interest expense on August 1, 2011; P Company, however, inadvertently failed to accrue interest income on the S Company bonds.
Included in P Company receivables is a $35,000 cash advance to S Company that was mailed on August 1, 2011. S Company had not yet received the advance at the time of the preparation of its August 1, 2011, balance sheet.
Assume that any excess of book value over the value implied by purchase price is due to overvalued plant and equipment.
The Aluminum Company of America (Alcoa) includes the following information in its 1997 Financial Report:
(Dollars in millions)
Income before income taxes
$1,601.7
Provision (expense) for income tax
528.7
Income taxes paid currently
445.5
Deferred tax liabilities related to depreciating assets at
December 31,1997
840.4
Required
Based solely on the information provided above
a. Determine Alcoa’s effective income tax rate during 1997.
b. Determine the percentage relation between Alcoa’s actual tax payments and income before taxes during 1997.
c. Provide a likely reason for the difference between the percentages determined in parts a and b above.
d. Assume that Alcoa’s statutory tax rate is 35 percent. What would you estimate as the difference between the tax basis and the book basis of Alcoa’s depreciable assets at the end of 1997?
22 Current financial accounting standards do not permit the discounting of deferred tax obligations, even in cases where the deferred obligations will not be paid for many years. Evaluate this practice. At minimum, address the following points:
a. Is it consistent to discount some long term debt (such as bonds payable), and not other long term liabilities (such as tax deferrals), and then add these amounts together in order to measure total liabilities? Why?
b. If deferred tax obligations are to be discounted, what rate should be used— a current market interest rate or some other rate? On the other hand, support the view that tax deferrals are essentially an “interest free” loan from the government and therefore they should be discounted at a zero interest rate.
c. If deferred tax obligations are to be discounted, and interest rates in general subsequently rise, how (if at all) would the carrying values of the deferred tax obligations be adjusted?
Cabot Cove’s annual report contained a note on long term debt. A partial list of the long term debt follows, exclusive of current maturities (dollars in thousands):
2000
1999
Notes due 2001, 9.875%
$150,000
$150,000
Notes due 2002 2022, 8.07%
105,000
105,000
Overseas Private Investment Corp.
due 2002, floating rate 6.5%
15,000
—
Industrial revenue bonds, due
2001 2014, 9.35% 14%
5,000
6,000
Required
a. Comment on why Cabot might have long term debt with such different interest rates and different maturities.
b. Based on current interest rates, which of these liabilities will sell above (or below) par values? Why?
c. Discuss how managers might use an aggressive debt retirement strategy to increase or decrease net income.
Yellow Jacket Company, which manufactures imaging and health products for commercial and medical customers, included the following information in a note describing its long term debt:
Long term debt (partial)
Issue:
(Dollars in Millions)
10.05% notes due 1999
$ 350
77/8% notes due 2001
135
8.55% notes due 2000
200
63/8% convertible debentures due 2001
278
Zero coupon convertible debentures due 2011
($3,680 face value)
1,127
Required
a. Why do the interest rates differ among the various debt issues reported by Yellow Jacket?
b. Why is information on these due dates useful to a financial analyst?
c. Assume that the prevailing market interest rate is 8.25% at the balance sheet date, and that each of the first four issues listed was initially issued at par (face) value. Which of these liabilities will have a current market value above par? Which issues would have a market value below par value?
d. If Yellow Jacket’s managers or board of directors wished to report a gain on early debt retirement. Which of these liabilities (see part c) will be retired first? Why?
e. Why would lenders be willing to invest in zero coupon bonds (bonds that do not pay periodic interest)?
Nuclear Indentures, a firm specializing in providing debt financing to high tech firms, provided the following information concerning restrictive covenants in its notes to the financial statements:
All long term obligations contain restrictive covenants including, among others, a requirement to maintain minimum working capital of $17,000,000, consolidated net worth . . . of not less than $25,000,000 and current assets greater than 200% of current liabilities.
The following amounts appear on the year end balance sheet (millions of dollars):
Current assets
$41.3
Total assets
$65.1
Current liabilities
$ 8.2
Total liabilities
$22.0
Required
a. Is Nuclear Indentures in compliance with its restrictive covenants?
b. By how much might the firm’s current assets decrease and still not violate the working capital restriction? (Assume current liabilities remain constant.)
c. By how much might the firm’s current assets decrease and still not violate the current ratio constraint? (Assume current liabilities remain constant.)
d. Why might a firm’s borrowing agreements restrict both the dollar amount of working capital and the current ratio?
Consider the following notes from the annual report of Jocko Enterprises. Interpret any unusual terms. How are lines of credit and long term debt used by Jocko’s managers? Explain how these notes indicate restrictions on managerial decisions. Alternatively, how do such liabilities create flexibility for managers?
Note 7—Line of Credit (Partial)
To be able to draw under the line, or if borrowings are outstanding, the agreement with the bank requires Jocko to maintain certain minimum levels of cash, cash equivalents, and/or certain marketable securities, working capital, and net worth. As of June 30, 1999, Jocko was in compliance with all the requirements. The agreement also provides that, except for borrowings represented by the 8.75% Convertible Subordinated Debentures due May 14, 2014 (the “debentures,” see Note 8), additional institutional borrowings cannot exceed $2,000,000 and seller or assumed financing of future acquisitions, if any, cannot exceed $5,000,000.
Note 8—Long Term Debt (Partial)
The debentures were issued under an indenture containing a number of restrictive covenants. These include restrictions on mergers and sales of assets and the creation of liens on assets; limitations on payments of cash dividends and purchases of Jocko’s common stock (see Note 9); and the use of the debenture proceeds by Jocko and its subsidiaries, which are reserved for the acquisition of other businesses, and, pending such acquisition, certain short term investments.
Review the balance sheet to determine how and when long term liabilities are reported.
Required
a. Read Note 8 “Long Term Debt.” Identify and discuss any unusual terms. Trace numerical disclosures of long term liabilities in the notes to corresponding disclosures in the financial statements.
b. Discuss any other unusual concerns regarding Reebok’s long term liabilities. What other related information might an external analyst prefer?
c. Note 8 contains a list of various debt issues, maturity dates, and interest rates. Comment on why Reebok might have long term debt issues with such different interest rates and different maturities.
d. Based on current interest rates, which of these do you think would sell above or below par values at today’s rates? Why?
e. Discuss how managers might use an aggressive debt retirement strategy to increase or decrease net income.
Use the balance sheet equation to analyze the financial statement effects of the following transactions involving long term bonds. Assume semiannual compounding.
Set up separate columns as necessary. Use a separate cash column.
a. Issue $10,000,000 of five year bonds carrying a coupon interest rate of 8% (paid semiannually). The market rate of interest at the time of issuance for similar bonds was 4%.
b. Record interest due and paid after the first six months.
c. Record interest due and paid at the end of the first year.
d. Record interest due and paid during each six month period during the second year.
e. How much cash will be paid at maturity (at the end of the fifth year)?
f. Show the effects of the bond repayment on the financial statements at the end of the fifth year.(Ignore any amortization of premium or discount in the last year.)
g. Discuss why these bonds were issued and recorded at a premium or discount.
Use the balance sheet equation to analyze the financial statement effects of the following transactions involving long term bonds. Assume semiannual compounding. Set up separate columns as necessary and use a separate cash column.
a. Issue $20,000,000 of five year bonds carrying a coupon interest rate of 8%, payable semiannually. The market rate of interest at the time of issuance for similar bonds was 12%.
b. Record interest paid after the first six months.
c. Record interest due and paid at the end of the first year.
d. Record interest due and paid during each six month period during the second year.
e. How much cash will be paid at the end of the fifth year?
f. Show the effects of the bond repayment on the financial statements at the end of the fifth year.
g. Discuss why these bonds were issued and recorded at a premium or discount.
Use the balance sheet equation to analyze the effects of the following transactions involving noncurrent liabilities. Set up separate columns as necessary for each liability. Use a separate column for cash.
1. A firm signed a long term note for $5 million for three years at an interest rate of 8% and received $5 million in cash.
2. The first interest payment was paid at the end of the first year.
3. The interest payment at the end of the second year was due, but wasn’t paid.
4. The note was paid at the end of the third year, including the accrued interest from year 2. Show the effects of each interest payment and the repayment separately. Assume that interest on any unpaid balances compounds; in other words, interest accrues on the unpaid interest carried over from year 2.
Transaction Analysis: Notes Payable and Simple Interest
Use the balance sheet equation to analyze the effects of the following transactions involving noncurrent liabilities. Set up separate accounts for each liability and use a separate column for cash.
1. Sally Shrimpton wanted to expand her pottery business, but had a negative cash flow. She borrowed $150,000 from her local bank and signed a note upon receipt of the cash.
2. Sally purchased a new kiln for $50,000 cash.
3. Sally purchased clay, paint, and other supplies for $20,000 cash.
4. Sally was paid a bonus of $25,000. She needed the cash to remodel her kitchen.
5. Interest for the first six months is due at an annual rate of 15%.
6. Sally paid the interest due.
7. Interest for the second six months is due.
8. Interest for the third six months is due.
9. Sally paid the interest for both six month periods and made partial payment of $50,000 on the loan.
10. Interest for the fourth six month period is due.
11. Interest for the final year (two six month periods) is due.
12. Sally fully paid the note, along with all accumulated interest.
Zany Sam’s issued $600,000 of six year, 8% bonds at a time when the market demanded a yield of 12% (on similar bonds). The bonds were issued on January 1, requiring interest payments on each subsequent June 30 and December 31 until maturity.
Required
a. Compute the issue price and determine the amount of any premium or discount at the issue date.
b. Using the balance sheet equation, show the effects of issuing the bonds on the financial statements.
c. Prepare a table showing the amortization of the discount or premium at each of the first four semiannual periods.
d. Under normal circumstances, how much cash will be paid at each interest date?
e. Determine the carrying value two years after the date of issue. (Reminder: The carrying value or book value of the bonds equals the face amount of the bonds plus the premium, or minus the discount.)
Dagwood’s issued $800,000 of 10 year, 8% bonds at a time when the market demanded a yield of 4% (on similar bonds). The bonds were issued on January 1, requiring interest payments on each subsequent June 30 and December 31 until maturity.
Required
a. Compute the issue price and determine the amount of any premium or discount at the issue date.
b. Show the effects of the bond issue on the financial statements, using the balance sheet equation.
c. Prepare a table showing the amortization of the discount or premium for each of the first four semiannual periods.
d. Under normal circumstances, how much cash will be paid at each interest date?
e. Determine the book value (face amount, plus premium or minus discount) two years after the date of issue.
f. Assume the bonds can be retired at 102 (102% of par value), two years after issue. Show the effects of this early retirement on the financial statements.
g. Why would a firm want to retire bonds early? Why would a firm pay more than book value to retire bonds early?
Sally Shrimpton’s pottery business was quite successful and needed to expand further. However, she wanted to avoid paying periodic interest payments to the bank. She saw an ad for discounted notes and decided they were preferable, compared to an interest bearing note. Show the effects of each of the following transactions on the balance sheet equation. Set up separate columns as necessary and use a separate cash column.
1. Sally signed a discounted, three year, $200,000 note (see Chapter 8) and received the proceeds. When she got home and read the fine print on the note, she found that the note doesn’t require periodic interest payments as intended. She also found, however, that the note includes a 12% interest rate. She was convinced that the bank made a mistake. On her next bank statement, she was surprised and shocked that her account didn’t show a deposit of $200,000 into her account on the day she signed the note; in fact, the deposit was much less. Calculate the loan proceeds and determine the effects of the loan on the firm’s balance sheet equation.
2. Because Sally now understands that interest is included in all notes, whether she makes any periodic interest payments, record interest expense for the first year.
3. Record interest expense for each of the next two years.
4. Record the final payment on the note.
5. What payment would Sally have been required to make if she had repaid the note at the end of the second year? Why wouldn’t she pay the entire $200,000 if she repaid the note at the end of the second year?
Interpreting Financial Statements: Ratio Calculations
Oncogene Science, Inc., reported no long term debt in its 1994 financial statements.
The equity section of its balance sheet can be summarized as:
1994
1993
Total current liabilities
$ 2,979,555
$ 2,460,060
Total long term liabilities
405,031
109,875
Total stockholders’ equity
38,656,314
45,044,603
Total liabilities and equity
$42,040,900
$47,614,538
Required
a. Calculate Oncogene’s debt and equity composition ratios (vertical analysis) using the capital composition ratios first introduced in Chapter 3.
b. Using only the information shown above, what does this evidence say, pro and con, about Oncogene’s ability to meet its liabilities? Would this suggest a high or low likelihood of bankruptcy? Why?
c. What other information would you need to assess the firm’s liquidity? Its default risk?
Interpreting Financial Statements: Ratio Calculations
Sigma Designs repaid much of its long term debt between January 31, 1994 and
January 31, 1995. Its liabilities and stock holders’ equity at January 31 were as follows
(dollars in thousands):
1995
1994
Total current liabilities
$13,564
$ 8,622
Total long term liabilities
1,102
1,518
Total shareholders’ equity
18,721
16,499
Total liabilities and equity
$33,387
$26,639
Required
a. Calculate Sigma Designs’ debt and equity composition ratios (vertical analysis).
b. Using only the information shown above, what does this evidence say, pro and con, about Sigma Designs’ ability to meet its liabilities? Would this suggest
a high or low likelihood of bankruptcy? Why?
c. What other information would be helpful in assessing the firm’s liquidity? Its default risk?
Interpreting Financial Statements: Ratio Calculations
Pfizer, Inc. reported these subtotals in its 1997 annual report (dollars in millions):
1997
1996
1995
Total current liabilities
$ 5,305
$ 5,640
$ 5,187
Total liabilities
7,403
7,713
7,223
Total shareholders’ equity
7,933
6,954
5,506
Total liabilities and equity
$15,336
$14,667
$12,729
Required
a. Calculate the debt and equity composition ratios (vertical analysis) for Pfizer for each year. (Hint: you must calculate the amount of any long term liabilities.)
b. Which factors indicate that Pfizer is a very stable company, especially with respect to its management of debt and equity? Would a more stable company generally have high or low risk of default? Why?
c. What other information should be examined before concluding that Pfizer is a stable company with low default risk?
Interpreting Financial Statements: Ratio Calculations
Exabyte Corporation reported the following subtotals in its 1994 annual report, in thousands of dollars, for the years ending December 31, 1994 and January 1, 1994 (note that these dates still represent two consecutive fiscal years):
December 31
January 1
1994
1994
Total current liabilities
$ 45,621
$ 38,318
Long term obligations
237
454
Total stockholders’ equity
196,907
158,535
Total liabilities and equity
$242,765
$197,307
Required
a. Calculate Exabyte’s debt and equity composition ratios (vertical analysis).
b. Which factors indicate that Exabyte has a low risk of default on its long term debt?
c. What is Exabyte’s apparent debt management strategy?
d. Which other indicators might be used to assess Exabyte’s risk of default?
e. Can the most recent year be compared with the fiscal year ended January 1,
1994? Why would a company change its year end by a few days? What other information would be helpful in assessing these issues?
Maggie Markel’s Moving Emporium needs to acquire additional capital in order to purchase new trucks and warehouse storage space, and to conduct a national advertising campaign. Maggie has heard of bonds and thinks that her friends and relatives would buy them if they were especially attractive. Although bonds issued by similar moving companies are currently yielding about 8% compounded semiannually, she decided to be kind to her friends and relatives and offer an interest rate of 10% compounded semiannually on the bonds. Maggie has never heard of premiums or discounts on bonds and intends to sell the bonds at their face amount (par).
Required
a. How many $1,000 bonds must Maggie issue at par in order to raise $1,000,000?
b. Write a memo to Maggie explaining the possible effects and consequences of selling $1,000,000 of 10% bonds at par when similar bonds yield 8%.
c. If Maggie sells the bonds at their market value, including an appropriate premium or discount, how much would Maggie receive for the $1,000,000 bonds? (Assume five year bonds.) How realistic is this assumption? Why?
d. Write a short memo summarizing your recommendations to Maggie about issuing these bonds.
e. Now assume that bonds similar to those issued by Maggie Markel’s Moving Emporium are very risky and require an interest rate of 12% compounded semiannually (6% each six months) before they can be sold to anyone, even to Maggie’s friends and relatives. Recalculate the issue price and any discount or premium.
Interpreting Financial Statements: Long Term Liabilities
Hansel, Inc., is an international company specializing in debt collection with a range of complementary credit management services. It is headquartered in Amsterdam and aims to maintain and enhance its position as Europe’s leading force in debt collection. Its 1999 financial statements list bank loans of £17,000,000 (£= pounds sterling) with the following related note:
BANK LOANS
The company has entered into a syndicated loan facility of £25,400,000 of which £20,000,000 has been used as of December 31, 1999 (December 31, 1998: £13,000,000). £17,000,000 has been classified as long term (1998: £13,000,000). The facility expires on December 16, 2001. The interest is calculated at 1.5% over LIBOR. A fee of 0.5% p.a. over the non utilized part of the facility is payable. There are no additional costs on an early redemption.
Required
a. Explain each of the unusual terms or provisions described in this footnote. Note that “LIBOR” is the “London Inter Bank Offer Rate” and that “p.a.” means “per annum” or annually.
b. Calculate the annual fee on the unused portion of this credit arrangement, assuming the above balances were all outstanding during 1999.
c. Assuming no changes in monetary amounts, will these liabilities be shown as a current liability at the end of 2000? What must happen for them to remain as a long term liability?
d. What amount must be included as the long term liability on the balance sheet at the end of 1999? Why?
e. From the perspective of management, what else would you like to know about these long term debts that is not shown in the financial statements?
f. For an investor evaluating a large international company, are these significant and unusual long term debts?
g. How does the accounting disclosure of these long term debts compare to the treatment of 30 year bonds discussed in this chapter?
Liis Company lost 70% of its inventory in a fire on March 25, 2014. The accounting records showed the following gross profit data for February and March.
February
March (to 3/25)
Net sales
$300,000
$250,000
Net purchases
176,800
139,000
Freight in
3,900
3,000
Beginning inventory
4,500
20,200
Ending inventory
20,200
?
Liis Company is fully insured for fire losses but must prepare a report for the insurance company.
Instructions
(a) Compute the gross profit rate for the month of February.
(b) Using the gross profit rate for February, determine both the estimated total inventory and inventory lost in the fire in March.
On December 1, 2014, Matthias Company had the account balances shown below.
Debit
Credit
Cash
$ 4,800
Accumulated Depreciation—Equipment
$ 1,500
Accounts Receivable
3,900
Accounts Payable
3,000
Inventory
1,800*
Owner”s Capital
27,000
Equipment
21,000
$31,500
$31,500
The following transactions occurred during December.
3
Purchased 4,000 units of inventory on account at a cost of $0.72 per unit.
5
Sold 4,400 units of inventory on account for $0.90 per unit. (It sold 3,000 of the $0.60 units and 1,400 of the $0.72.)
7
Granted the December 5 customer $180 credit for 200 units of inventory returned costing $120. These units were returned to inventory.
17
Purchased 2,200 units of inventory for cash at $0.80 each.
22
Sold 2,000 units of inventory on account for $0.95 per unit. (It sold 2,000 of the $0.72 units.)
Adjustment data:
1. Accrued salaries payable $400.
2. Depreciation $200 per month.
Instructions
(a) Journalize the December transactions and adjusting entries, assuming Matthias uses the perpetual inventory method.
(b) Enter the December 1 balances in the ledger T accounts and post the December transactions. In addition to the accounts mentioned above, use the following additional accounts: Cost of Goods Sold, Depreciation Expense, Salaries and Wages Expense, Salaries and Wages Payable, Sales Revenue, and Sales Returns and Allowances.
(c) Prepare an adjusted trial balance as of December 31, 2014.
(d) Prepare an income statement for December 2014 and a classified balance sheet at December 31, 2014.
(e) Compute ending inventory and cost of goods sold under FIFO, assuming Matthias Company uses the periodic inventory system.
(f) Compute ending inventory and cost of goods sold under LIFO, assuming Matthias Company uses the periodic inventory system.
The notes that accompany a company”s financial statements provide informative details that would clutter the amounts and descriptions presented in the statements. Refer to the financial statements of Apple Inc. as well as its annual report. Instructions for accessing and using the company”s complete annual report, including the notes to the financial statements, are also provided.
Instructions
Answer the following questions. Complete the requirements in millions of dollars, as shown in Apple”s annual report.
(a) What did Apple report for the amount of inventories in its consolidated balance sheet at September 25, 2010? At September 24, 2011?
(b) Compute the dollar amount of change and the percentage change in inventories between 2010 and 2011. Compute inventory as a percentage of current assets at September 24, 2011.
(c) How does Apple value its inventories? Which inventory cost flow method does Apple use? (d) What is the cost of sales (cost of goods sold) reported by Apple for 2011, 2010, and 2009? Compute the percentage of cost of sales to net sales in 2011.
On April 10, 2014, fire damaged the office and warehouse of Corvet Company. Most of the accounting records were destroyed, but the following account balances were determined as of March 31, 2014: Inventory (January 1, 2014), $80,000; Sales Revenue (January 1–March 31, 2014), $180,000; Purchases (January 1–March 31, 2014), $94,000.
The company”s fiscal year ends on December 31. It uses a periodic inventory system.
From an analysis of the April bank statement, you discover cancelled checks of $4,200 for cash purchases during the period April 1–10. Deposits during the same period totaled $18,500. Of that amount, 60% were collections on accounts receivable, and the balance was cash sales.
Correspondence with the company”s principal suppliers revealed $12,400 of purchases on account from April 1 to April 10. Of that amount, $1,600 was for merchandise in transit on April 10 that was shipped FOB destination.
Correspondence with the company”s principal customers produced acknowledgments of credit sales totaling $37,000 from April 1 to April 10. It was estimated that $5,600 of credit sales will never be acknowledged or recovered from customers.
Corvet Company reached an agreement with the insurance company that its fire loss claim should be based on the average of the gross profit rates for the preceding 2 years. The financial statements for 2012 and 2013 showed the following data.
2013
2012
Net sales
$600,000
$480,000
Cost of goods purchased
404,000
356,000
Beginning inventory
60,000
40,000
Ending inventory
80,000
60,000
Inventory with a cost of $17,000 was salvaged from the fire.
Instructions
With the class divided into groups, answer the following.
(a) Determine the balances in (1) Sales Revenue and (2) Purchases at April 10.
(b) Determine the average gross profit rate for the years 2012 and 2013.
(c) Determine the inventory loss as a result of the fire, using the gross profit method.
R. J. Graziano Wholesale Corp. uses the LIFO method of inventory costing. In the current year, profit at R. J. Graziano is running unusually high. The corporate tax rate is also high this year, but it is scheduled to decline significantly next year. In an effort to lower the current year”s net income and to take advantage of the changing income tax rate, the president of R. J. Graziano Wholesale instructs the plant accountant to recommend to the purchasing department a large purchase of inventory for delivery 3 days before the end of the year. The price of the inventory to be purchased has doubled during the year, and the purchase will represent a major portion of the ending inventory value.
Instructions
(a) What is the effect of this transaction on this year”s and next year”s income statement and income tax expense? Why?
(b) If R. J. Graziano Wholesale had been using the FIFO method of inventory costing, would the president give the same directive?
(c) Should the plant accountant order the inventory purchase to lower income? What are the ethical implications of this order?
Franklin Company has the following four items in its ending inventory as of December 31, 2014. The company uses the lower of cost or net realizable value approach for inventory valuation following IFRS.
Item No.
Cost
Net Realizable Value
AB
$1,700
$1,400
TRX
2,200
2,300
NWA
7,800
7,100
SGH
3,000
3,700
Compute the lower of cost or net realizable value.
Presented below is information related to Sims Company for its first month of operations. Determine the balances that appear in the accounts payable subsidiary ledger. What Accounts Payable balance appears in the general ledger at the end of January?
Credit Purchases
Cash Paid
Jan. 5
Devon Co.
$11,000
Jan. 9
Devon Co.
$7,000
11
Shelby Co.
7,000
14
Shelby Co.
2,000
22
Taylor Co.
14,000
27
Taylor Co.
9,000
Subtract cash paid from credit purchases to determine the balances in the accounts payable subsidiary ledger.
Sum the individual balances to determine the Accounts Payable balance.
Dotel Company”s cash receipts journal includes an Accounts Receivable column and an Other Accounts column. At the end of the month, these columns are posted to the general ledger as:
Spelling Entertainment, which produces films and videos and other entertainment media, lists the following items in its 1994 annual report (dollars in thousands):
1994
1993
1992
1991
Property, plant, and equipment
net
$ 16,161
$ 4,770
$ 4,834
$ 6,331
Other assets
19,678
4,562
6,512
13,879
Net assets held for disposition
0
0
0
16,475
Intangibles, net of accumulated
amortization of $17,671,
$10,527, $6,713 and
$2,626
400,751
1,549,983
159,291
154,946
Revenues
$599,839
$ 274,899
$257,546
$122,748
Operating income
50,743
39,727
25,315
13,987
Required
Part I
a. Describe each of Spelling’s non current assets.
b. Identify any unusual trends or unusual terms.
c. Calculate fixed asset turnover for 1993 and 1994. Use property, plant, and equipment, net.
Part II
d. How does Spelling seem to be managing its fixed assets? What evidence supports your conclusion?
e. Why are intangibles Spelling’s largest noncurrent asset? What problems might this create, especially if these intangibles represent copyrights and trademarks that are no longer fashionable?
Part III
f. What additional information is needed before you can calculate Spelling’s percentage of PPE depreciated?
g. Where might you find such information?
h. Upon carefully reading the notes to Spelling’s 1994 financial statements, you do not find the requisite information. What would you do next to find this information?
Part IV
Further review of Spelling’s notes reveals the following additional information about its asset disposal strategy or the effects thereof. Net assets (liabilities) held for disposition consisted of the following at December 31, (dollars in thousands):
1994
1993
1992
1991
Receivables, net
$ 608
$ 2,714
$ 7,445
$40,282
Investments
0
0
0
2,600
Property, plant, and equipment,
net
3,161
4,467
4,572
23,050
Other assets
0
0
247
5,280
Accounts payable and other
accruals
(1,749)
(1,780)
(4,023)
(16,681)
Notes payable
0
0
0
(19,500)
Other liabilities
0
0
(1,090)
(4,707)
$ 2,020
$ 5,401
$ 7,151
$30,324
Less allowance for estimated
estimated losses on
disposal of segment
(20,368)
(29,621)
(15,058)
(13,849)
$(18,348)
$(24,220)
$(7,907)
$16,475
i. Describe each item in the above note. Note that only one of the above subtotals was reported in Spelling’s balance sheet (see above, Part I). Where were the other subtotals reported? Why?
j. Discuss the implications of this note. What does this note imply about the valuations of Spelling’s other assets? Why?
k. How have Spelling’s perceptions regarding its asset disposal activities changed over the years? Why?
l. Would an external analyst view Spelling’s note as optimistic or worse? Why?
m. If Spelling completes its disposition program in 1995, what is the likely effect on 1995’s net income? Why?
Comprehensive Analysis: Fixed Assets
Spelling Entertainment, which produces films and videos and other entertainment media, lists the following items in its 1994 annual report (dollars in thousands):
1994
1993
1992
1991
Property, plant, and equipment
net
$ 16,161
$ 4,770
$ 4,834
$ 6,331
Other assets
19,678
4,562
6,512
13,879
Net assets held for disposition
0
0
0
16,475
Intangibles, net of accumulated
amortization of $17,671,
$10,527, $6,713 and
$2,626
400,751
1,549,983
159,291
154,946
Revenues
$599,839
$ 274,899
$257,546
$122,748
Operating income
50,743
39,727
25,315
13,987
Required
Part I
a. Describe each of Spelling’s non current assets.
b. Identify any unusual trends or unusual terms.
c. Calculate fixed asset turnover for 1993 and 1994. Use property, plant, and equipment, net.
Part II
d. How does Spelling seem to be managing its fixed assets? What evidence supports your conclusion?
e. Why are intangibles Spelling’s largest noncurrent asset? What problems might this create, especially if these intangibles represent copyrights and trademarks that are no longer fashionable?
Part III
f. What additional information is needed before you can calculate Spelling’s percentage of PPE depreciated?
g. Where might you find such information?
h. Upon carefully reading the notes to Spelling’s 1994 financial statements, you do not find the requisite information. What would you do next to find this information?
Part IV
Further review of Spelling’s notes reveals the following additional information about its asset disposal strategy or the effects thereof. Net assets (liabilities) held for disposition consisted of the following at December 31, (dollars in thousands):
1994
1993
1992
1991
Receivables, net
$ 608
$ 2,714
$ 7,445
$40,282
Investments
0
0
0
2,600
Property, plant, and equipment,
net
3,161
4,467
4,572
23,050
Other assets
0
0
247
5,280
Accounts payable and other
accruals
(1,749)
(1,780)
(4,023)
(16,681)
Notes payable
0
0
0
(19,500)
Other liabilities
0
0
(1,090)
(4,707)
$ 2,020
$ 5,401
$ 7,151
$30,324
Less allowance for estimated
estimated losses on
disposal of segment
(20,368)
(29,621)
(15,058)
(13,849)
$(18,348)
$(24,220)
$(7,907)
$16,475
i. Describe each item in the above note. Note that only one of the above subtotals was reported in Spelling’s balance sheet (see above, Part I). Where were the other subtotals reported? Why?
j. Discuss the implications of this note. What does this note imply about the valuations of Spelling’s other assets? Why?
k. How have Spelling’s perceptions regarding its asset disposal activities changed over the years? Why?
l. Would an external analyst view Spelling’s note as optimistic or worse? Why?
m. If Spelling completes its disposition program in 1995, what is the likely effect on 1995’s net income? Why?
Comprehensive Analysis: Noncurrent and Intangible Assets
Boudreaux Group is an international biochemical and pharmaceutical firm, headquartered in Switzerland. Its 1999 annual report includes the following (Swiss francs in millions):
1999
1998
1997
Property, plant, and equipment,
net
FF 7,010
FF 6,319
FF 5,815
Intangible assets
1,895
2,050
2,200
Other long term assets
1,583
1,313
1,064
Total long term assets
FF 10,488
FF 9,682
FF 9,079
Sales
FF 13,576
FF 12,702
FF 11,840
Gross profit
8,145
7,139
6,295
Gross (original) cost PPE
13,077
11,950
10,905
Intangible assets
Intangible assets comprise acquired intellectual property (including patents, technology, and know how), trademarks, licenses, and other similarly identified rights. They are recorded at their acquisition cost and are amortized over the lower of their legal or estimated economic lives up to a maximum of 10 years. Costs associated with internally developed intangible assets are expensed as incurred.
Required
a. Describe each of Boudreaux’s disclosures related to noncurrent assets.
b. For 1998 and 1999, calculate the fixed asset turnover.
c. For 1998 and 1999, calculate the percentage of PPE depreciated.
d. Discuss and interpret the results of these ratio computations.
e. With regard to intangibles, how has Boudreaux constrained some of the discretion and subjectivity that it might have had otherwise?
f. What impact does the term know how have on your analysis of Boudreaux’s noncurrent assets?
Inco Limited, headquartered in Toronto, is one of the world’s premier mining and metals companies. Its 1994 annual report contains the following note: Depreciation and Depletion Depreciation is calculated using the straight line method and, for the nickel operations in Indonesia, the units of production method, based on the estimated economic lives of property, plant, and equipment. Such lives are generally limited to a maximum of 20 years and are subject to annual review. Depletion is calculated by a method that allocates mine development costs ratably to the tons of ore mined.
Upon further study, you learn that the units of production depreciation method is very similar to the methods described in this chapter to determine depletion allowances.
Required
a. Identify and discuss each unusual term in this note.
b. Why would a company want to use more than one depreciation method?
c. Does the 20 year limitation on useful lives result in more conservative, or less conservative, measures of net income? What other information would you need to better assess this issue?
d. What choices does Inco Limited have during its annual review of useful lives?
What would be the most likely balance sheet and income statement effects of such a review? Why?
Sigma Designs is a diversified graphic systems corporation. Its statement of cash flows is summarized as follows:
Sigma Designs, Inc.
Statement of Cash Flows
For the Years Ended January 31, 1995 and 1994
1995
1994
Cash Flows from Operating Activities
(Dollars in thousands)
Net loss
$(8,773)
$(29,546)
Adjustments to reconcile net loss to net cash
provided by operating activities
(summary of all net adjustments)
(110)
15,885
Net cash provided by (used for) operating activities
(8,883)
(13,661)
Cash Flows from Investing Activities
Purchases of marketable securities
(25,350)
(22,542)
Sales of marketable securities
22,296
33,355
Equipment additions
(721)
(612)
Software development costs (capitalized)
(1,255)
(494)
Other asset transactions
0
183
Net cash provided (used for) investing activities
(5,030)
9,890
Cash Flows from Financing Activities
Common stock sold
13,201
493
Repayment of long term obligations
1,710
0
Other financing transactions
(1,925)
0
Net cash provided (used for) financing activities
12,986
493
Decrease in cash and equivalents
$ (927)
$ (3,278)
Required
a. What does the category of cash flows shown as “Software development costs (capitalized)”represent? Who has received these cash payments?
b. Do these “Software development costs” payments seem material, relative to the size of Sigma Designs? How would your views change if the cash payment was $3,000,000 each year?
Becky’s Courier Service is a one person, one bicycle operation. Becky’s only capital equipment is a highly specialized, custom designed mountain bike that can be used throughout the urban jungle.
Required
a. Assume that Becky’s mountain bike broke, what accounting recognition should be given to this tragedy?
b. How would your answer change if the bike had been stolen? Why?
c. Assume that Becky’s mountain bike was destroyed in a fire while chained in a bike rack at a client’s site. The client’s insurance company provided Becky with a check for the replacement cost of the bicycle, which was twice its original price. What accounting recognition should be given to this event?
The president of your company clearly wants to report as large a net income number as possible. Part of your responsibility as the controller is to determine if certain expenditures should be expensed or capitalized. Knowing the president’s wishes, which of the following expenditures would you capitalize? Support each choice with proper accounting reasons and ethical behavior.
a. Painting costs (part of the factory and office building are painted each year)
b. Costs to repair cracks in the parking lot
c. Cost of tree pruning on corporate grounds
d. Cost to produce brochures that will be given to prospective customers next year
For each of the following companies, locate the most recent 10 K available using the EDGAR database Walt Disney Corp., Schering Plough, Oncogene Science, Chicago Tribune, John Wiley & Co., RJR Nabisco, and Macromedia Inc.
Required
a. Identify a unique intangible asset owned by each company.
b. For each intangible asset, identify (1) its value in both dollars and as a percentage of total assets and (2) the method of amortization used. (Hint: You will find useful and relevant information in the Notes to the Financial Statements.)
c. Compare and contrast the different types of intangible assets reported by each company.
d. Identify any instances where one of these firms tried to “manage” its earnings by changing its method of amortizing intangible assets.
Companies in different industries naturally use different assets in daily operations.
The differences are reflected in both type and amount of long term tangible assets. Locate, from 10 Ks on file with EDGAR the latest balance sheet and Notes to the Financial Statements for the following companies:
• Ameritech (telecommunications)
• Bank One (banking)
• Boeing (airplane manufacturing)
• Dole (food products)
• Southwest Airlines (air transportation)
Required
a. Before looking at the 10 Ks, list the types of long term tangible assets that would normally be included on each company’s balance sheet.
b. Identify the primary long term tangible assets for each company and determine the percent of total assets it represents.
c. Comment on any observed differences across these various industries.
Kerr McGee Corporation, a global energy and chemical company, includes the following information in a footnote describing the long term debt reported in its 1997 financial statements:
Long term debt (Partial)
(Dollars in millions)
7.125% Debentures due October 15, 2027 (7.01% effective rate)
$ 150
7% Debentures due November 1, 2011, net of unamortized debt discount of
$108 million in 1997 and $111 million in 1996 (14.25% effective rate)
142
8 1/2% Sinking fund debentures due June 1, 2006
22
Notes payable
6.625% Notes due October 15, 2007 (6.54% effective rate)
150
Other
90
Required
a. Why do the interest rates differ among the various debt issues reported by Kerr McGee?
b. Why is the information concerning the due dates of Kerr McGee’s debt useful to the analyst?
c. Note that the coupon rates and effective interest rates differ for several of Kerr McGee’s debt issues. Based on the information provided above, which of these issues was sold at a discount? Which was sold at a premium?
d. Assume that the market rate of interest on similar debt is 10 percent at the balance sheet date (December 31, 1997). If so, would the market values of the first two issues listed above be greater or less than their book values? Explain.
e. Based on your answer to part d, if Kerr McGee’s management wished to report a gain on early debt retirement, which of the issues would be retired?
The following information concerning restrictive covenants has been adapted from footnotes to the 1996 financial statements of Nuclear Metals, Inc., a metallurgical technology firm:
The Industrial Revenue Bonds (IRBs) outstanding consist of two note issues. The interest rates on these notes range from 66.5% to 70% of the bank’s prime interest rate. These notes are secured by property, plant, and equipment. The IRBs contain restrictive covenants including, among others, a requirement to maintain minimum working capital, consolidated net worth, and a minimum current ratio The following amounts appear on the year end balance sheet:
Current assets
$18,633,000
Total assets
35,118,000
Current liabilities
9,384,000
Total liabilities
10,878,000
Required
a. Assume for purposes of illustration that Nuclear Metals, Inc.’s restrictive covenants require minimum working capital of $7,000,000, consolidated net worth of not less than $20,000,000, and current assets greater than 150% of current liabilities. Would the firm be in compliance with these covenants at the end of 1996?
b. By how much might the firm’s current assets decrease and still not violate the working capital restriction? (Assume that current liabilities remain constant.)
c. By how much might the firm’s current assets decrease and still not violate the current ratio constraint? (Assume that current liabilities remain constant.)
d. Why might lenders restrict both the current ratio and the dollar amount of working capital in restrictive covenants?
Gepetto Shoe Store uses the retail inventory method for its two departments, Women”s Shoes and Men”s Shoes. The following information for each department is obtained.
Item
Women”s Shoes
Men”s Shoes
Beginning inventory at cost
$ 25,000
$ 45,000
Cost of goods purchased at cost
110,000
136,300
Net sales
178,000
185,000
Beginning inventory at retail
46,000
60,000
Cost of goods purchased at retail
179,000
185,000
Instructions
Compute the estimated cost of the ending inventory for each department under the retail inventory method.
Austin Limited is trying to determine the value of its ending inventory as of February 28, 2014, the company”s year end. The following transactions occurred, and the accountant asked your help in determining whether they should be recorded or not.
(a) On February 26, Austin shipped goods costing $800 to a customer and charged the customer $1,000. The goods were shipped with terms FOB shipping point and the receiving report indicates that the customer received the goods on March 2.
(b) On February 26, Louis Inc. shipped goods to Austin under terms FOB shipping point. The invoice price was $450 plus $30 for freight. The receiving report indicates that the goods were received by Austin on March 2.
(c) Austin had $650 of inventory isolated in the warehouse. The inventory is designated for a customer who has requested that the goods be shipped on March 10.
(d) Also included in Austin”s warehouse is $700 of inventory that Ryhn Producers shipped to Austin on consignment.
(e) On February 26, Austin issued a purchase order to acquire goods costing $900. The goods were shipped with terms FOB destination on February 27. Austin received the goods on March 2.
(f) On February 26, Austin shipped goods to a customer under terms FOB destination. The invoice price was $350; the cost of the items was $200. The receiving report indicates that the goods were received by the customer on March 2.
Instructions
For each of the above transactions, specify whether the item in question should be included in ending inventory, and if so, at what amount.
Express Distribution markets CDs of the performing artist Fishe. At the beginning of October, Express had in beginning inventory 2,000 of Fishe”s CDs with a unit cost of $7. During October, Express made the following purchases of Fishe”s CDs.
Oct. 3 2,500
@
$8
Oct. 19 3,000
@
$10
Oct. 9 3,500
@
$9
Oct. 25 4,000
@
$11
During October, 10,900 units were sold. Express uses a periodic inventory system.
Instructions
(a) Determine the cost of goods available for sale.
(b) Determine (1) the ending inventory and (2) the cost of goods sold under each of the assumed cost flow methods (FIFO, LIFO, and average cost). Prove the accuracy of the cost of goods sold under the FIFO and LIFO methods.
(c) Which cost flow method results in (1) the highest inventory amount for the balance sheet and (2) the highest cost of goods sold for the income statement?
Ziad Company had a beginning inventory on January 1 of 150 units of Product 4 18 15 at a cost of $20 per unit. During the year, the following purchases were made.
Mar. 15
400 units at $23
Sept. 4
350 units at $26
20 Jul
250 units at $24
Dec. 2
100 units at $29
1,000 units were sold. Ziad Company uses a periodic inventory system.
Instructions
(a) Determine the cost of goods available for sale.
(b) Determine (1) the ending inventory, and (2) the cost of goods sold under each of the assumed cost flow methods (FIFO, LIFO, and average cost). Prove the accuracy of the cost of goods sold under the FIFO and LIFO methods.
(c) Which cost flow method results in (1) the highest inventory amount for the balance sheet, and (2) the highest cost of goods sold for the income statement?
The management of Felipe Inc. is reevaluating the appropriateness of using its present inventory cost flow method, which is average cost. The company requests your help in determining the results of operations for 2014 if either the FIFO or the LIFO method had been used. For 2014, the accounting records show these data:
Inventories
Purchases and Sales
Beginning (7,000 units)
$14,000
Total net sales (180,000 units)
$747,000
Ending (17,000 units)
Total cost of goods purchased(190,000 units)
466,000
Purchases were made quarterly as follows.
Quarter
Units
Unit Cost
Total Cost
1
50,000
$2.20
$110,000
2
40,000
2.35
941000
3
40,000
2.50
100,000
4
60,000
2.70
162,000
190,000
$466,000
Operating expenses were $130,000, and the company”s income tax rate is 40%.
Instructions
(a) Prepare comparative condensed income statements for 2014 under FIFO and LIFO.
(b) Answer the following questions for management.
(1) Which cost flow method (FIFO or LIFO) produces the more meaningful inventory amount for the balance sheet? Why?
(2) Which cost flow method (FIFO or LIFO) produces the more meaningful net income? Why?
(3) Which cost flow method (FIFO or LIFO) is more likely to approximate the actual physical flow of goods? Why?
(4) How much more cash will be available for management under LIFO than under FIFO? Why?
(5) Will gross profit under the average cost method be higher or lower than FIFO? Than LIFO?
You are provided with the following information for Barton Inc. Barton Inc. uses the periodic method of accounting for its inventory transactions.
March 1
Beginning inventory 2,000 liters at a cost of 60¢ per liter.
March 3
Purchased 2,500 liters at a cost of 65¢ per liter.
March 5
Sold 2,300 liters for $1.05 per liter.
March 10
Purchased 4,000 liters at a cost of 72¢ per liter.
March 20
Purchased 2,500 liters at a cost of 80¢ per liter.
March 30
Sold 5,200 liters for $1.25 per liter.
Instructions
(a) Prepare partial income statements through gross profit, and calculate the value of ending inventory that would be reported on the balance sheet, under each of the following cost flow assumptions. (Round ending inventory and cost of goods sold to the nearest dollar.)
(1) Specific identification method assuming:
(i) The March 5 sale consisted of 1,000 liters from the March 1 beginning inventory and 1,300 liters from the March 3 purchase; and
(ii) The March 30 sale consisted of the following number of units sold from beginning inventory and each purchase: 450 liters from March 1; 550 liters from March 3; 2,900 liters from March 10; 1,300 liters from March 20.
(2) FIFO.
(3) LIFO.
(b) How can companies use a cost flow method to justify price increases? Which cost flow method would best support an argument to increase prices?
The management of Sherlynn Co. asks your help in determining the comparative effects of the FIFO and LIFO inventory cost flow methods. For 2014, the accounting records provide the following data.
Inventory, January 1 (10,000 units)
$ 45,000
Cost of 100,000 units purchased
532,000
Selling price of 80,000 units sold
700,000
Operating expenses
140,000
Units purchased consisted of 35,000 units at $5.10 on May 10; 35,000 units at $5.30 on August 15; and 30,000 units at $5.60 on November 20. Income taxes are 30%.
Instructions
(a) Prepare comparative condensed income statements for 2014 under FIFO and LIFO. (Show computations of ending inventory.)
(b) Answer the following questions for management.
(1) Which inventory cost flow method produces the most meaningful inventory amount for the balance sheet? Why?
(2) Which inventory cost flow method produces the most meaningful net income? Why?
(3) Which inventory cost flow method is most likely to approximate actual physical flow of the goods? Why?
(4) How much additional cash will be available for management under LIFO than under FIFO? Why?
(5) How much of the gross profit under FIFO is illusory in comparison with the gross profit under LIFO?
Mercer Inc. is a retailer operating in British Columbia. Mercer uses the perpetual inventory method. All sales returns from customers result in the goods being returned to inventory; the inventory is not damaged. Assume that there are no credit transactions; all amounts are settled in cash. You are provided with the following information for Mercer Inc. for the month of January 2014.
Unit Cost or
Date
Description
Quantity
Selling Price
January 1
Beginning inventory
100
$15
January 5
Purchase
140
18
January 8
Sale
110
28
January 10
Sale return
10
28
January 15
Purchase
55
20
January 16
Purchase return
5
20
January 20
Sale
90
32
Janurary 25
Purchase
20
22
Instructions
(a) For each of the following cost flow assumptions, calculate (i) cost of goods sold, (ii) ending inventory, and (iii) gross profit.
(1) LIFO.
(2) FIFO.
(3) Moving average cost.
(b) Compare results for the three cost flow assumptions.
Suzuki Company lost all of its inventory in a fire on December 26, 2014. The accounting records showed the following gross profit data for November and December.
November
December (to 12/26)
Net sales
$600,000
$700,000
Beginning inventory
32,000
36,000
Purchases
389,000
420,000
Purchase returns and allowances
13,300
14,900
Purchase discounts
8,500
9,500
Freight in
8,800
9,900
Ending inventory
36,000
Suzuki is fully insured for fire losses but must prepare a report for the insurance company.
Instructions
(a) Compute the gross profit rate for November.
(b) Using the gross profit rate for November, determine the estimated cost of the inventory lost in the fire.
Dixon Books uses the retail inventory method to estimate its monthly ending inventories. The following information is available for two of its departments at October 31, 2014.
Hardcovers
Paperbacks
Cost
Retail
Cost
Retail
Beginning inventory
$ 420,000
$ 700,000
$ 280,000
$ 360,000
Purchases
2,135,000
3,200,000
1,155,000
1,540,000
Freight in
24,000
12,000
Purchase discounts
44,000
22,000
Net sales
3,100,000
1,570,000
At December 31, Dixon Books takes a physical inventory at retail. The actual retail values of the inventories in each department are Hardcovers $790,000 and Paperbacks $335,000.
Instructions
(a) Determine the estimated cost of the ending inventory for each department at October 31, 2014, using the retail inventory method.
(b) Compute the ending inventory at cost for each department at December 31, assuming the cost to retail ratios for the year are 65% for Hardcovers and 75% for Paperbacks.
Weber Limited is trying to determine the value of its ending inventory at February 28, 2014, the company”s year end. The accountant counted everything that was in the warehouse as of February 28, which resulted in an ending inventory valuation of $48,000. However, she didn”t know how to treat the following transactions so she didn”t record them.
(a) On February 26, Weber shipped to a customer goods costing $800. The goods were shipped FOB shipping point, and the receiving report indicates that the customer received the goods on March 2.
(b) On February 26, Gretel Inc. shipped goods to Weber FOB destination. The invoice price was $350. The receiving report indicates that the goods were received by Weber on March 2.
(c) Weber had $500 of inventory at a customer”s warehouse “on approval.” The customer was going to let Weber know whether it wanted the merchandise by the end of the week, March 4.
(d) Weber also had $400 of inventory on consignment at a Roslyn craft shop.
(e) On February 26, Weber ordered goods costing $750. The goods were shipped FOB shipping point on February 27. Weber received the goods on March 1.
(f) On February 28, Weber packaged goods and had them ready for shipping to a customer FOB destination. The invoice price was $350; the cost of the items was $250. The receiving report indicates that the goods were received by the customer on March 2.
(g) Weber had damaged goods set aside in the warehouse because they are no longer saleable. These goods cost $400 and Weber originally expected to sell these items for $600.
Instructions
For each of the above transactions, specify whether the item in question should be included in ending inventory and, if so, at what amount. For each item that is not included in ending inventory, indicate who owns it and in what account, if any, it should have been recorded.
Xinxin Distribution markets CDs of the performing artist Carly. At the beginning of March, Xinxin had in beginning inventory 1,500 Carly CDs with a unit cost of $7. During March Xinxin made the following purchases of Carly CDs.
March 5
3,000@$8
March 21
4,000@$10
March 13
4,500@$9
March 26
2,500@$11
During March, 12,000 units were sold. Xinxin uses a periodic inventory system.
Instructions
(a) Determine the cost of goods available for sale.
(b) Determine (1) the ending inventory and (2) the cost of goods sold under each of the assumed cost flow methods (FIFO, LIFO, and average cost). Prove the accuracy of the cost of goods sold under the FIFO and LIFO methods.
(c) Which cost flow method results in (1) the highest inventory amount for the balance sheet and (2) the highest cost of goods sold for the income statement?
Walz Company had a beginning inventory of 400 units of Product Ribo at a cost of $8 per unit. During the year, purchases were:
Feb. 20
600 units at $9
Aug. 12
300 units at $11
5 May
500 units at $10
Dec. 8
200 units at $12
Walz Company uses a periodic inventory system. Sales totaled 1,500 units.
Instructions
(a) Determine the cost of goods available for sale.
(b) Determine (1) the ending inventory and (2) the cost of goods sold under each of the assumed cost flow methods (FIFO, LIFO, and average cost). Prove the accuracy of the cost of goods sold under the FIFO and LIFO methods.
(c) Which cost flow method results in (1) the lowest inventory amount for the balance sheet, and (2) the lowest cost of goods sold for the income statement?
You have the following information for Princess Diamonds. Princess Diamonds uses the periodic method of accounting for its inventory transactions. Princess only carries one brand and size of diamonds—all are identical. Each batch of diamonds purchased is carefully coded and marked with its purchase cost.
March
1
Beginning inventory 150 diamonds at a cost of $300 per diamond.
March
3
Purchased 200 diamonds at a cost of $360 each.
March
5
Sold 180 diamonds for $600 each.
March
10
Purchased 350 diamonds at a cost of $380 each.
March
25
Sold 400 diamonds for $650 each.
Instructions
(a) Assume that Princess Diamonds uses the specific identification cost flow method.
(1) Demonstrate how Princess Diamonds could maximize its gross profit for the month by specifically selecting which diamonds to sell on March 5 and March 25.
(2) Demonstrate how Princess Diamonds could minimize its gross profit for the month by selecting which diamonds to sell on March 5 and March 25.
(b) Assume that Princess Diamonds uses the FIFO cost flow assumption. Calculate cost of goods sold. How much gross profit would Princess Diamonds report under this cost flow assumption?
(c) Assume that Princess Diamonds uses the LIFO cost flow assumption. Calculate cost of goods sold. How much gross profit would the company report under this cost flow assumption?
(d) Which cost flow method should Princess Diamonds select? Explain.
The management of Chelsea Inc. asks your help in determining the comparative effects of the FIFO and LIFO inventory cost flow methods. For 2014, the accounting records provide the following data.
Inventory, January 1 (10,000 units)
$ 35,000
Cost of 120,000 units purchased
504,500
Selling price of 100,000 units sold
665,000
Operating expenses
130,000
Units purchased consisted of 35,000 units at $4.00 on May 10; 60,000 units at $4.20 on August 15; and 25,000 units at $4.50 on November 20. Income taxes are 28%.
Instructions
(a) Prepare comparative condensed income statements for 2014 under FIFO and LIFO. (Show computations of ending inventory.)
(b) Answer the following questions for management in the form of a business letter.
(1) Which inventory cost flow method produces the most meaningful inventory amount for the balance sheet? Why?
(2) Which inventory cost flow method produces the most meaningful net income? Why?
(3) Which inventory cost flow method is most likely to approximate the actual physical flow of the goods? Why?
(4) How much more cash will be available for management under LIFO than under FIFO? Why?
(5) How much of the gross profit under FIFO is illusionary in comparison with the gross profit under LIFO?
Minsoo Ltd. is a retailer operating in Edmonton, Alberta. Minsoo uses the perpetual inventory method. All sales returns from customers result in the goods being returned to inventory; the inventory is not damaged. Assume that there are no credit transactions; all amounts are settled in cash. You are provided with the following information for Minsoo Ltd. for the month of January 2014.
Date
Description
Quantity
Unit Cost or Selling Price
December 31
Ending inventory
160
$17
January 2
Purchase
100
21
January 6
Sale
150
40
January 9
Sale return
10
40
January 9
Purchase
80
24
January 10
Purchase return
10
24
January 10
Sale
60
45
January 23
Purchase
100
28
January 30
Sale
110
50
Instructions
(a) For each of the following cost flow assumptions, calculate (i) cost of goods sold, (ii) ending inventory, and (iii) gross profit.
(1) LIFO.
(2) FIFO.
(3) Moving average cost.
(b) Compare results for the three cost flow assumptions.
Buffet Appliance Mart began operations on May 1. It uses a perpetual inventory system. During May, the company had the following purchases and sales for its Model 25 Sureshot camera.
Purchases
Date
Units
Unit Cost
Sales Units
May 1
7
$150
4
4
8
8
$170
12
5
15
6
$185
20
3
254
Instructions
(a) Determine the ending inventory under a perpetual inventory system using (1) FIFO, (2) moving average cost, and (3) LIFO.
(b) Which costing method produces (1) the highest ending inventory valuation and (2) the lowest ending inventory valuation?
The accounting records of Shumway Ag Implements show the following data.
Beginning inventory
4,000 units at $ 3
Purchases
6,000 units at $ 4
Sales
7,000 units at $12
Determine the cost of goods sold during the period under a periodic inventory system using (a) the FIFO method, (b) the LIFO method, and (c) the average cost method.
Understand the periodic inventory system.
Allocate costs between goods sold and goods on hand (ending inventory) for each cost flow method.
(a) Tracy Company sells three different types of home heating stoves (gas, wood, and pellet). The cost and market value of its inventory of stoves are as follows.
Cost
Market
Gas
$ 84,000
$ 79,000
Wood
250,000
280,000
Pellet
112,000
101,000
Determine the value of the company”s inventory under the lower of cost or market approach.
Determine whether cost or market value is lower for each inventory type.
Sum the lowest value of each inventory type to determine the total value of inventory.
Early in 2014, Westmoreland Company switched to a just in time inventory system. Its sales revenue, cost of goods sold, and inventory amounts for 2013 and 2014 are shown below.
Determine the inventory turnover and days in inventory for 2013 and 2014. Discuss the changes in the amount of inventory, the inventory turnover and days in inventory, and the amount of sales across the two years.
Action Plan
To find the inventory turnover, divide cost of goods sold by average inventory.
To determine days in inventory, divide 365 days by the inventory turnover.
Just in time inventory reduces the amount of inventory on hand, which reduces carrying costs. Reducing inventory levels by too much has potential negative implications for sales.
Gerald D. Englehart Company has the following inventory, purchases, and sales data for the month of March.
Inventory:
March 1
200 units @
$4.00
$ 800
Purchases:
March 10
500 units @
$4.50
2,250
March 20
400 units @
$4.75
1,900
March 30
300 units @
$5.00
1,500
Sales:
March 15
500 units
March 25
400 units
The physical inventory count on March 31 shows 500 units on hand.
Instructions
Under a periodic inventory system, determine the cost of inventory on hand at March 31 and the cost of goods sold for March under (a) FIFO, (b) LIFO, and (c) average cost.
Compute the total goods available for sale, in both units and dollars.
Compute the cost of ending inventory under the periodic FIFO method by allocating to the units on hand the latest costs.
Compute the cost of ending inventory under the periodic LIFO method by allocating to the units on hand the earliest costs.
Compute the cost of ending inventory under the periodic average cost method by allocating to the units on hand a weighted average cost.
Showed cost of goods sold computations under a periodic inventory system. Now let”s assume that Gerald D. Englehart Company uses a perpetual inventory system. The company has the same inventory, purchases, and sales data for the month of March as shown earlier:
Inventory:
March 1
200 units @
$4.00
$ 800
Purchases:
March 10
500 units @
$4.50
2,250
March 20
400 units @
$4.75
1,900
March 30
300 units @
$5.00
1,500
Sales:
March 15
500 units
March 25
400 units
The physical inventory count on March 31 shows 500 units on hand.
Instructions
Under a perpetual inventory system, determine the cost of inventory on hand at March 31 and the cost of goods sold for March under (a) FIFO, (b) LIFO, and (c) moving average cost.
Compute the cost of goods sold under the perpetual FIFO method by allocating to the goods sold the earliest cost of goods purchased.
Compute the cost of goods sold under the perpetual LIFO method by allocating to the goods sold the latest cost of goods purchased.
Compute the cost of goods sold under the perpetual average cost method by allocating to the goods sold a moving average cost.
Gomez Company just took its physical inventory. The count of inventory items on hand at the company”s business locations resulted in a total inventory cost of $300,000. In reviewing the details of the count and related inventory transactions, you have discovered the following.
1. Gomez has sent inventory costing $26,000 on consignment to Kako Company. All of this inventory was at Kako”s showrooms on December 31.
2. The company did not include in the count inventory (cost, $20,000) that was sold on December 28, terms FOB shipping point. The goods were in transit on December 31.
3. The company did not include in the count inventory (cost, $17,000) that was purchased with terms of FOB shipping point. The goods were in transit on December 31.
Early in 2014, Chien Company switched to a just in time inventory system. Its sales, cost of goods sold, and inventory amounts for 2013 and 2014 are shown below.
2013
2014
Sales
$3,120,000
$3,713,000
Cost of goods sold
1,200,000
1,425,000
Beginning nventody
180,000
220,000
Ending inventory
220,000
100,000
Determine the inventory turnover and days in inventory for 2013 and 2014. Discuss the changes in the amount of inventory, the inventory turnover and days in inventory, and the amount of sales across the two years.
Tri State Bank and Trust is considering giving Josef Company a loan. Before doing so, management decides that further discussions with Josef”s accountant may be desirable. One area of particular concern is the inventory account, which has a year end balance of $297,000. Discussions with the accountant reveal the following.
1. Josef sold goods costing $38,000 to Sorci Company, FOB shipping point, on December 28. The goods are not expected to arrive at Sorci until January 12. The goods were not included in the physical inventory because they were not in the warehouse.
2. The physical count of the inventory did not include goods costing $95,000 that were shipped to Josef FOB destination on December 27 and were still in transit at year end.
3. Josef received goods costing $22,000 on January 2. The goods were shipped FOB shipping point on December 26 by Solita Co. The goods were not included in the physical count.
4. Josef sold goods costing $35,000 to Natali Co., FOB destination, on December 30. The goods were received at Natali on January 8. They were not included in Josef”s physical inventory.
5. Josef received goods costing $44,000 on January 2 that were shipped FOB destination on December 29. The shipment was a rush order that was supposed to arrive December 31. This purchase was included in the ending inventory of $297,000.
Instructions
Determine the correct inventory amount on December 31.
Rachel Warren, an auditor with Laplante CPAs, is performing a review of Schuda Company”s inventory account. Schuda did not have a good year, and top management is under pressure to boost reported income. According to its records, the inventory balance at year end was $740,000. However, the following information was not considered when determining that amount.
1. Included in the company”s count were goods with a cost of $250,000 that the company is holding on consignment. The goods belong to Harmon Corporation.
2. The physical count did not include goods purchased by Schuda with a cost of $40,000 that were shipped FOB destination on December 28 and did not arrive at Schuda warehouse until January 3.
3. Included in the inventory account was $14,000 of office supplies that were stored in the warehouse and were to be used by the company”s supervisors and managers during the coming year.
4. The company received an order on December 29 that was boxed and sitting on the loading dock awaiting pick up on December 31. The shipper picked up the goods on January 1 and delivered them on January 6. The shipping terms were FOB shipping point. The goods had a selling price of $40,000 and a cost of $28,000. The goods were not included in the count because they were sitting on the dock.
5. On December 29, Schuda shipped goods with a selling price of $80,000 and a cost of $60,000 to Reza Sales Corporation FOB shipping point. The goods arrived on January 3. Reza Sales had only ordered goods with a selling price of $10,000 and a cost of $8,000. However, a sales manager at Schuda had authorized the shipment and said that if Reza wanted to ship the goods back next week, it could.
6. Included in the count was $40,000 of goods that were parts for a machine that the company no longer made. Given the high tech nature of Schuda”s products, it was unlikely that these obsolete parts had any other use. However, management would prefer to keep them on the books at cost, “since that is what we paid for them, after all.”
Instructions
Prepare a schedule to determine the correct inventory amount. Provide explanations for each item above, saying why you did or did not make an adjustment for each item.
On December 1, Marzion Electronics Ltd. has three DVD players left in stock. All are identical, all are priced to sell at $150. One of the three DVD players left in stock, with serial #1012, was purchased on June 1 at a cost of $100. Another, with serial #1045, was purchased on November 1 for $90. The last player, serial #1056, was purchased on November 30 for $80.
Instructions
(a) Calculate the cost of goods sold using the FIFO periodic inventory method assuming that two of the three players were sold by the end of December, Marzion Electronics’ year end.
(b) If Marzion Electronics used the specific identification method instead of the FIFO method, how might it alter its earnings by “selectively choosing” which particular players to sell to the two customers? What would Marzion”s cost of goods sold be if the company wished to minimize earnings? Maximize earnings?
(c) Which of the two inventory methods do you recommend that Marzion use? Explain why.
Linda”s Boards sells a snowboard, Xpert, that is popular with snowboard enthusiasts. Information relating to Linda”s purchases of Xpert snowboards during September is shown below. During the same month, 121 Xpert snowboards were sold. Linda”s uses a periodic inventory system.
Date
Explanation
Units
Unit Cost
Total Cost
1
Inventory
26
$ 97
$ 2,522
Sept. 12
Purchases
45
102
4,590
Sept. 19
Purchases
20
104
2,080
Sept. 26
Purchases
50
105
5,250
Totals
141
$14,442
Instructions
(a) Compute the ending inventory at September 30 and cost of goods sold using the FIFO and LIFO methods. Prove the amount allocated to cost of goods sold under each method.
(b) For both FIFO and LIFO, calculate the sum of ending inventory and cost of goods sold. What do you notice about the answers you found for each method?
Xiong Co. uses a periodic inventory system. Its records show the following for the month of May, in which 65 units were sold.
Units
Unit Cost
Total Cost
May 1
Inventory
30
$ 8
$240
15
Purchases
25
11
275
24
Purchases
35
12
420
Totals
90 =
$935
Instructions
Compute the ending inventory at May 31 and cost of goods sold using the FIFO and LIFO methods. Prove the amount allocated to cost of goods sold under each method.
Rulix Watch Company reported the following income statement data for a 2 year period.
2013
2014
Sales revenue
$220,000
$250,000
Cost of goods sold
Beginning inventory
32,000
44,000
Cost of goods purchased
173,000
202,000
Cost of goods available for sale
205,000
246,000
Ending inventory
44,000
52,000
Cost of goods sold
161,000
194,000
Gross profit
$ 59,000
$ 56,000
Rulix uses a periodic inventory system. The inventories at January 1, 2013, and December 31, 2014, are correct. However, the ending inventory at December 31, 2013, was overstated $6,000.
Instructions
(a) Prepare correct income statement data for the 2 years.
(b) What is the cumulative effect of the inventory error on total gross profit for the 2 years?
(c) Explain in a letter to the president of Rulix Watch Company what has happened, i.e., the nature of the error and its effect on the financial statements.
Information about Linda”s Boards is presented in E6 4. Additional data regarding Linda”s sales of Xpert snowboards are provided below. Assume that Linda”s uses a perpetual inventory system.
Date
Units
Unit Price
Total Revenue
Sept. 5
Sale
12
$199
$ 2,388
Sept. 16
Sale
50
199
9,950
Sept. 29
Sale
59
209
12,331
Totals
121
$24,669
Instructions
(a) Compute ending inventory at September 30 using FIFO, LIFO, and moving average cost.
(b) Compare ending inventory using a perpetual inventory system to ending inventory using a periodic inventory system .
(c) Which inventory cost flow method (FIFO, LIFO) gives the same ending inventory value under both periodic and perpetual? Which method gives different ending inventory values?
The Deluxe Store is located in midtown Madison. During the past several years, net income has been declining because of suburban shopping centers. At the end of the company”s fiscal year on November 30, 2014, the following accounts appeared in two of its trial balances.
Unadjusted
Adjusted
Unadjusted
Adjusted
Accounts Payable
$ 25,200
$ 25,200
Notes Payable
$ 37,000
$ 37,000
Accounts Receivable
30,500
30,500
Owner”s Capital
101,700
101,700
Accumulated Depr. Equip.
34,000
45,000
Owner”s Drawings
10,000
10,000
Cash
26,000
26,000
Prepaid Insurance
10,500
3,500
Cost of Goods Sold
507,000
507,000
Property Tax Expense
2,500
Freight Out
6,500
6,500
Property Taxes Payable
2,500
Equipment
146,000
146,000
Rent Expense
15,000
15,000
Depreciation Expense
11,000
Salaries and Wages Expense
96,000
96,000
Insurance Expense
7,000
Sales Revenue
700,000
700,000
Interest Expense
6,400
6,400
Sales Commissions Expense
6,500
11,000
Interest Revenue
8,000
8,000
Sales Commissions Payable
4,500
Inventory
29,000
29,000
Sales Returns and Allowances
8,000
8,000
Utilities Expense
8,500
8,500
Instructions
(a) Prepare a multiple step income statement, an owner”s equity statement, and a classified balance sheet. Notes payable are due in 2017.
(b) Journalize the adjusting entries that were made.
(c) Journalize the closing entries that are necessary.
(a) Net income $29, 100 Owner”s capital $120,800 Total assets $190,000
Adam Nichols, a former disc golf star, operates Adam”s Discorama. At the beginning of the current season on April 1, the ledger of Adam”s Discorama showed Cash $1,800, Inventory $2,500, and Owner”s Capital $4,300. The following transactions were completed during April.
5
Purchased golf discs, bags, and other inventory on account from Rayford Co. $1,200, FOB shipping point, terms 2/10, n/60.
7
Paid freight on the Rayford purchase $50.
9
Received credit from Rayford Co. for merchandise returned $100.
10
Sold merchandise on account for $900, terms n/30. The merchandise sold had a cost of $540.
12
Purchased disc golf shirts and other accessories on account from Galaxy Sportswear $670, terms 1/10, n/30.
14
Paid Rayford Co. in full, less discount.
17
Received credit from Galaxy Sportswear for merchandise returned $70.
20
Made sales on account for $610, terms n/30. The cost of the merchandise sold was $370.
21
Paid Galaxy Sportswear in full, less discount.
27
Granted an allowance to customers for clothing that was flawed $20.
30
Received payments on account from customers $900.
The chart of accounts for the store includes the following: No. 101 Cash, No. 112 Accounts Receivable, No. 120 Inventory, No. 201 Accounts Payable, No. 301 Owner”s Capital, No. 401 Sales Revenue, No. 412 Sales Returns and Allowances, and No. 505 Cost of Goods Sold.
Instructions
(a) Journalize the April transactions using a perpetual inventory system.
(b) Enter the beginning balances in the ledger accounts and post the April transactions.
The trial balance of Valdez Fashion Center contained the following accounts at November 30, the end of the company”s fiscal year.
VAIDEZ FASHION CENTER Trial Balance November 30, 2014
Cash
Accounts Receivable
Inventory
Supplies
Equipment
Debit
Credit
$8,700
30,700 44,700 6,200 133,000
Accumulated Depreciation—Equipment
$ 28,000
Notes Payable
51,000
Accounts Payable
48,500
Owner”s Capital
90,000
Owner”s Drawings
12,000
Sales Revenue
755,200
Sales Returns and Allowances
8,800
Cost of Goods Sold
497,400
Salaries and Wages Expense
140,000
Advertising Expense
24,400
Utilities Expense
14,000
Maintenance and Repairs Expense
12,100
Freight Out
16,700
Rent Expense
24,000
Totals
$972,700
$972,700
Adjustment data:
1. Supplies on hand totaled $2,000.
2. Depreciation is $11,500 on the equipment.
3. Interest of $4,000 is accrued on notes payable at November 30.
4. Inventory actually on hand is $44,400.
Instructions
(a) Enter the trial balance on a worksheet, and complete the worksheet.
(b) Prepare a multiple step income statement and an owner”s equity statement for the year, and a classified balance sheet as of November 30, 2014. Notes payable of $20,000 are due in January 2015.
Alana Inc. operates a retail operation that purchases and sells home entertainment products. The company purchases all merchandise inventory on credit and uses a periodic inventory system. The Accounts Payable account is used for recording inventory purchases only; all other current liabilities are accrued in separate accounts. You are provided with the following selected information for the fiscal years 2011 through 2014, inclusive.
2011
2012
2013
2014
Income Statement Data
Sales revenue
$55,000
(e)
$47,000
Cost of goods sold
(a)
13,800
14,300
Gross profit
38,300
35,200
(i)
Operating expenses
34,900
(1)
28,600
Net income
(b)
$ 2,500
(0)
Balance Sheet Data
Inventory
$7,200
(c)
$ 8,100
(k)
Accounts payable
3,200
3,600
2,500
Additional Information
Purchases of merchandise inventory on account
$14,200
(g)
$13,200
Cash payments to suppliers
(d)
(h)
13,600
Instructions
(a) Calculate the missing amounts.
(b) Sales declined over the 3 year fiscal period, 2012–2014. Does that mean that profit ability necessarily also declined? Explain, computing the gross profit rate and the profit margin for each fiscal year to help support your answer. (Round to one decimal place.)
At the beginning of the current season on April 1, the ledger of Kokott Pro Shop showed Cash $3,000; Inventory $4,000; and Owner”s Capital $7,000. These transactions occurred during April 2014.
5
Purchased golf bags, clubs, and balls on account from Hogan Co. $1,200, FOB shipping point, terms 2/10, n/60.
7
Paid freight on Hogan Co. purchases $50.
9
Received credit from Hogan Co. for merchandise returned $100.
10
Sold merchandise on account to customers $600, terms n/30.
12
Purchased golf shoes, sweaters, and other accessories on account from Duffer Sportswear $450, terms 1/10, n/30.
14
Paid Hogan Co. in full.
17
Received credit from Duffer Sportswear for merchandise returned $50.
20
Made sales on account to customers $600, terms n/30.
21
Paid Duffer Sportswear in full.
27
Granted credit to customers for clothing that had flaws $35.
30
Received payments on account from customers $600.
The chart of accounts for the pro shop includes Cash, Accounts Receivable, Inventory, Accounts Payable, Owner”s Capital, Sales Revenue, Sales Returns and Allowances, Purchases, Purchase Returns and Allowances, Purchase Discounts, and Freight In.
Instructions
(a) Journalize the April transactions using a periodic inventory system.
(b) Using T accounts, enter the beginning balances in the ledger accounts and post the April transactions.
(c) Prepare a trial balance on April 30, 2014.
(d) Prepare an income statement through gross profit, assuming merchandise inventory on hand at April 30 is $4,824.
Urdan Co. distributes suitcases to retail stores and extends credit terms of 1/10, n/30 to all of its customers. At the end of June, Urdan”s inventory consisted of suitcases costing $1,200. During the month of July, the following merchandising transactions occurred.
July
1
Purchased suitcases on account for $1,800 from Hostad Manufacturers, FOB destination, terms 2/10, n/30. The appropriate party also made a cash payment of $100 for freight on this date.
3
Sold suitcases on account to Kaye Satchels for $2,000. The cost of suitcases sold is $1,200.
9
Paid Hostad Manufacturers in full.
12
Received payment in full from Kaye Satchels.
17
Sold suitcases on account to The Going Concern for $1,800. The cost of the suitcases sold was $1,080.
18
Purchased suitcases on account for $1,900 from Nelson Manufacturers, FOB shipping point, terms 1/10, n/30. The appropriate party also made a cash payment of $125 for freight on this date.
20
Received $300 credit (including freight) for suitcases returned to Nelson Manufacturers.
21
Received payment in full from The Going Concern.
22
Sold suitcases on account to Wopat”s for $2,250. The cost of suitcases sold was $1,350.
30
Paid Nelson Manufacturers in full.
31
Granted Wopat”s $200 credit for suitcases returned costing $120.
Urdan”s chart of accounts includes the following: No. 101 Cash, No. 112 Accounts Receivable, No. 120 Inventory, No. 201 Accounts Payable, No. 401 Sales Revenue, No. 412 Sales Returns and Allowances, No. 414 Sales Discounts, and No. 505 Cost of Goods Sold.
Instructions
Journalize the transactions for the month of July for Urdan using a perpetual inventory system.
Rose Distributing Company completed the following merchandising transactions in the month of April. At the beginning of April, the ledger of Rose showed Cash of $9,000 and Owner”s Capital of $9,000.
2
Purchased merchandise on account from Kwon Supply Co. $6,900, terms 1/10, n/30.
4
Sold merchandise on account $6,500, FOB destination, terms 1/10, n/30. The cost of the merchandise sold was $3,900.
5
Paid $240 freight on April 4 sale.
6
Received credit from Kwon Supply Co. for merchandise returned $500.
11
Paid Kwon Supply Co. in full, less discount.
13
Received collections in full, less discounts, from customers billed on April 4.
14
Purchased merchandise for cash $3,800.
16
Received refund from supplier for returned goods on cash purchase of April 14, $500.
18
Purchased merchandise from Davis Distributors $4,500, FOB shipping point, terms 2/10, n/30.
20
Paid freight on April 18 purchase $100.
23
Sold merchandise for cash $7,400. The merchandise sold had a cost of $4,120.
26
Purchased merchandise for cash $2,300.
27
Paid Davis Distributors in full, less discount.
29
Made refunds to cash customers for defective merchandise $90. The returned merchandise had a fair value of $30.
30
Sold merchandise on account $3,700, terms n/30. The cost of the merchandise sold was $2,800.
Rose Distributing Company”s chart of accounts includes the following: No. 101 Cash, No. 112 Accounts Receivable, No. 120 Inventory, No. 201 Accounts Payable, No. 301 Owner”s Capital, No. 401 Sales Revenue, No. 412 Sales Returns and Allowances, No. 414 Sales Discounts, No. 505 Cost of Goods Sold, and No. 644 Freight Out.
Instructions
(a) Journalize the transactions using a perpetual inventory system.
(b) Enter the beginning cash and capital balances, and post the transactions.
(c) Prepare the income statement through gross profit for the month of April 2014.
Mackey Department Store is located near the Village Shopping Mall. At the end of the company”s calendar year on December 31, 2014, the following accounts appeared in two of its trial balances.
Unadjusted
Adjusted
Unadjusted
Adial
Accounts Payable
$ 79,300
$ 80,300
Inventory
$ 75,000
$ 75,000
Accounts Receivable
50,300
50,300
Mortgage Payable
80,000
80,000
Accumulated Depr. Buildings
42,100
52,500
Owner”s Capital
176,600
176,600
Accumulated Depr. Equipment
29,600
42,900
Owner”s Drawings
28,000
28,000
Buildings
290,000
290,000
Prepaid Insurance
9,600
2,400
Cash
23,800
23,800
Property Tax Expense
4,800
Cost of Goods Sold
412,700
412,700
Property Taxes Payable
4,800
Depreciation Expense
23,700
Salaries and Wages Expense
108,000
108,000
Equipment
110,000
110,000
Sales Commissions Expense
10,200
14,500
Insurance Expense
7,200
Sales Commissions Payable
4,300
Interest Expense
3,000
12,000
Sales Returns and Allowances
8,000
8,000
Interest Payable
9,000
Sales Revenue
728,000
728,000
Interest Revenue
4,000
4,000
Utilities Expense
11,000
12,000
Instructions
(a) Prepare a multiple step income statement, an owner”s equity statement, and a classified balance sheet. $25,000 of the mortgage payable is due for payment next year.
(b) Journalize the adjusting entries that were made.
(c) Journalize the closing entries that are necessary.
Alex Diaz, a former professional tennis star, operates Diaz Tennis Shop at the Cedar Lake Resort. At the beginning of the current season, the ledger of Diaz Tennis Shop showed Cash $2,500, Inventory $1,700, and Owner”s Capital $4,200. The following transactions were completed during April.
4
Purchased racquets and balls from Marx Co. $840, FOB shipping point, terms 2/10, n/30.
6
Paid freight on purchase from Marx Co. $40.
8
Sold merchandise to members $1,150, terms n/30. The merchandise sold had a cost of $790.
10
Received credit of $40 from Marx Co. for a racquet that was returned.
11
Purchased tennis shoes from Rupp Sports for cash, $420.
13
Paid Marx Co. in full.
14
Purchased tennis shirts and shorts from Hayley”s Sportswear $900, FOB shipping point, terms 3/10, n/60.
15
Received cash refund of $50 from Rupp Sports for damaged merchandise that was returned.
17
Paid freight on Hayley”s Sportswear purchase $30.
18
Sold merchandise to members $900, terms n/30. The cost of the merchandise sold was $540.
20
Received $600 in cash from customers in settlement of their accounts.
21
Paid Hayley”s Sportswear in full.
27
Granted an allowance of $40 to members for tennis clothing that did not fit properly.
30
Received cash payments on account from customers, $710.
The chart of accounts for the tennis shop includes the following: No. 101 Cash, No. 112 Accounts Receivable, No. 120 Inventory, No. 201 Accounts Payable, No. 301 Owner”s Capital, No. 401 Sales Revenue, No. 412 Sales Returns and Allowances, and No. 505 Cost of Goods Sold.
Instructions
(a) Journalize the April transactions using a perpetual inventory system.
(b) Enter the beginning balances in the ledger accounts and post the April transactions. (Use J1 for the journal reference.)
Val Knight operates a retail clothing operation. She purchases all merchandise inventory on credit and uses a periodic inventory system. The Accounts Payable account is used for recording inventory purchases only; all other current liabilities are accrued in separate accounts. You are provided with the following selected information for the fiscal years 2011–2014.
2011
2012
2013
2014
Inventory (ending)
$13,000
$ 11,300
$ 14,700
$ 12,200
Accounts payable (ending)
20,000
Sales revenue
239,000
237,000
235,000
Purchases of merchandise inventory on account
146,000
145,000
129,000
Cash payments to suppliers
135,000
161,000
127,000
Instructions
(a) Calculate cost of goods sold for each of the 2012, 2013, and 2014 fiscal years.
(b) Calculate the gross profit for each of the 2012, 2013, and 2014 fiscal years.
(c) Calculate the ending balance of accounts payable for each of the 2012, 2013, and 2014 fiscal years.
(d) Sales declined in fiscal 2014. Does that mean that profitability, as measured by the gross profit rate, necessarily also declined? Explain, calculating the gross profit rate for each fiscal year to help support your answer. (Round to one decimal place.)
At the beginning of the current season, the ledger of Everett Tennis Shop showed Cash $2,500; Inventory $1,700; and Owner”s Capital $4,200. The following transactions were completed during April.
4
Purchased racquets and balls from Riggs Co. $740, terms 3/10, n/30.
6
Paid freight on Riggs Co. purchase $60.
8
Sold merchandise to customers $900, terms n/30.
10
Received credit of $40 from Riggs Co. for a racquet that was returned.
11
Purchased tennis shoes from King Sports for cash $300.
13
Paid Riggs Co. in full.
14
Purchased tennis shirts and shorts from BJ Sportswear $700, terms 2/10, n/60.
15
Received cash refund of $50 from King Sports for damaged merchandise that was returned.
17
Paid freight on BJ Sportswear purchase $30.
18
Sold merchandise to customers $1,000, terms n/30.
20
Received $500 in cash from customers in settlement of their accounts.
21
Paid BJ Sportswear in full.
27
Granted an allowance of $25 to customers for tennis clothing that did not fit properly.
30
Received cash payments on account from customers $550.
The chart of accounts for the tennis shop includes Cash, Accounts Receivable, Inventory, Accounts Payable, Owner”s Capital, Sales Revenue, Sales Returns and Allowances, Purchases, Purchase Returns and Allowances, Purchase Discounts, and Freight In.
Instructions
(a) Journalize the April transactions using a periodic inventory system.
(b) Using T accounts, enter the beginning balances in the ledger accounts and post the April transactions.
(c) Prepare a trial balance on April 30, 2014.
(d) Prepare an income statement through gross profit, assuming inventory on hand at April 30 is $2,296.
On December 1, 2014, Prosen Distributing Company had the following account balances.
Cash
Debit
Accumulated Depreciation—
Credit
$ 7,200
Accounts Receivable
4,600
Equipment
$ 2,200
Inventory
12,000
Accounts Payable
4,500
Supplies
1,200
Salaries and Wages Payable
1,000
Equipment
22,000
Owner”s Capital
39,300
$47,000
$47,000
During December, the company completed the following summary transactions.
6
Paid $1,600 for salaries and wages due employees, of which $600 is for December and $1,000 is for November salaries and wages payable.
8
Received $1,900 cash from customers in payment of account (no discount allowed).
10
Sold merchandise for cash $6,300. The cost of the merchandise sold was $4,100.
13
Purchased merchandise on account from Maglio Co. $9,000, terms 2/10, n/30.
15
Purchased supplies for cash $2,000.
18
Sold merchandise on account $12,000, terms 3/10, n/30. The cost of the merchandise sold was $8,000.
20
Paid salaries and wages $1,800.
23
Paid Maglio Co. in full, less discount.
27
Received collections in full, less discounts, from customers billed on December 18.
Adjustment data:
1. Accrued salaries and wages payable $800.
2. Depreciation $200 per month.
3. Supplies on hand $1,500.
Instructions
(a) Journalize the December transactions using a perpetual inventory system.
(b) Enter the December 1 balances in the ledger T accounts and post the December transactions. Use Cost of Goods Sold, Depreciation Expense, Salaries and Wages Expense, Sales Revenue, Sales Discounts, and Supplies Expense.
(c) Journalize and post adjusting entries.
(d) Prepare an adjusted trial balance.
(e) Prepare an income statement and an owner”s equity statement for December and a classified balance sheet at December 31.
Inc.”s financial statements are presented. Financial statements of Wal Mart Stores, Inc. are presented. Instructions for accessing and using the complete annual reports of Amazon and Wal Mart, including the notes to the financial statements, are also provided in Appendices D and E, respectively.
Instructions
(a) Based on the information contained in these financial statements, determine each of the following for each company. Use Amazon”s net product sales to compute gross profit information.
(1) Gross profit for 2011.
(2) Gross profit rate for 2011.
(3) Operating income for 2011.
(4) Percentage change in operating income from 2010 to 2011.
(b) What conclusions concerning the relative profitability of the two companies can you draw from these data?
Three years ago, Dana Mann and her brother in law Eric Boldt opened Family Department Store. For the first two years, business was good, but the following condensed income results for 2013 were disappointing.
FAMILY DEPARTMENT STORE Income Statement For the Year Ended December 31, 2013
Net sales
$700,000
Cost of goods sold
553,000
Gross profit
147,000
Operating expenses
$100,000
Selling expenses
Administrative expenses
20,000
120,000
Net income
$ 27,000
Dana believes the problem lies in the relatively low gross profit rate (gross profit divided by net sales) of 21%. Eric believes the problem is that operating expenses are too high.
Dana thinks the gross profit rate can be improved by making both of the following changes. She does not anticipate that these changes will have any effect on operating expenses.
1. Increase average selling prices by 17%. This increase is expected to lower sales volume so that total sales will increase only 6%.
2. Buy merchandise in larger quantities and take all purchase discounts. These changes are expected to increase the gross profit rate by 3 percentage points.
Eric thinks expenses can be cut by making both of the following changes. He feels that these changes will not have any effect on net sales.
1. Cut 2013 sales salaries of $60,000 in half and give sales personnel a commission of 2% of net sales.
2. Reduce store deliveries to one day per week rather than twice a week. This change will reduce 2013 delivery expenses of $30,000 by 40%.
Dana and Eric come to you for help in deciding the best way to improve net income.
Instructions
With the class divided into groups, answer the following.
(a) Prepare a condensed income statement for 2014, assuming (1) Dana”s changes are implemented and (2) Eric”s ideas are adopted.
(b) What is your recommendation to Dana and Eric?
(c) Prepare a condensed income statement for 2014, assuming both sets of proposed changes are made.
Jacquie Boynton was just hired as the assistant treasurer of Key West Stores. The company is a specialty chain store with nine retail stores concentrated in one metropolitan area. Among other things, the payment of all invoices is centralized in one of the departments Jacquie will manage. Her primary responsibility is to maintain the company”s high credit rating by paying all bills when due and to take advantage of all cash discounts.
Phelan Carter, the former assistant treasurer who has been promoted to treasurer, is training Jacquie in her new duties. He instructs Jacquie that she is to continue the practice of preparing all checks “net of discount” and dating the checks the last day of the discount period. “But,” Phelan continues, “we always hold the checks at least 4 days beyond the discount period before mailing them. That way, we get another 4 days of interest on our money. Most of our creditors need our business and don”t complain. And, if they scream about our missing the discount period, we blame it on the mail room or the post office. We”ve only lost one discount out of every hundred we take that way. I think everybody does it. By the way, welcome to our team!”
Instructions
(a) What are the ethical considerations in this case?
(b) Who are the stakeholders that are harmed or benefitted in this situation?
(c) Should Jacquie continue the practice started by Phelan? Does she have any choice?
There are many situations in business where it is difficult to determine the proper period in which to record revenue. Suppose that after graduation with a degree in finance, you take a job as a manager at a consumer electronics store called Impact Electronics. The company has expanded rapidly in order to compete with Best Buy. Impact has also begun selling gift cards for its electronic products. The cards are available in any dollar amount and allow the holder of the card to purchase an item for up to 2 years from the time the card is purchased. If the card is not used during that 2 years, it expires.
Instructions
Answer the following questions.
At what point should the revenue from the gift cards be recognized? Should the revenue be recognized at the time the card is sold, or should it be recorded when the card is redeemed? Explain the reasoning to support your answers.
Hasbeen Company completed its inventory count. It arrived at a total inventory value of $200,000. As a new member of Hasbeen”s accounting department, you have been given the information listed below. Discuss how this information affects the reported cost of inventory.
1. Hasbeen included in the inventory goods held on consignment for Falls Co., costing $15,000.
2. The company did not include in the count purchased goods of $10,000 which were in transit (terms: FOB shipping point).
3. The company did not include in the count sold inventory with a cost of $12,000 which was in transit (terms: FOB shipping point).
Apply the rules of ownership to goods held on consignment.
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Page 1 of 4 FACULTY OF BUSINESS AND LAW ACFI2001 Company Accounting Semester 1, 2014 Assignment 2 Weighting: 20 Marks (worth 10%) Due Date: Friday 23 May, 2014, 11:59pm Weighting: 10% All assignments are to be submitted electronically on Blackboard via Turnitin. The assignment must be attempted and completed individually and submitted by 11:59pm on the due date. Turnitin reports can be used as evidence by the lecturer in the event that plagiarism is suspected in an assignment. Suspected acts of plagiarism will be forwarded to the Student Academic Conduct Officer (SACO). Any assignment submitted late will be penalised at a rate of 10% per day of the possible maximum mark for the assignment for each day or part day that the assessment is late. Any assignment submitted more than five days after the due date will be awarded zero marks. Assignment Details You are the financial accountant for a mid sized company and you have been briefed on a meeting that has taken place last week. In that meeting the marketing department discussed the merits of joining a network involving a virtual currency to promote business. In the meeting the adoption of Bitcoin (a very popular virtual currency) and Emoney were discussed, however due to the security issues, the idea of adopting Bitcoin was dismissed. The way the virtual currency Emoney works is via a network of suppliers and clients through the network “ENet” and the use of “Emoney”. Emoney is the virtual currency that is used to transact within the network. 1 unit of Emoney is equal to 1 Australian dollar. Each time a company that is within the ENet network provides a good or service to another member within the Network, the value of the service is recorded in “Emoney” and is added to Page 2 of 4 the company’s Emoney balance. This value of Emoney can then be exchanged for goods and services provided by companies within the network and the balance updated accordingly. There is no active market for Emoney, it has no physical substance and cannot be exchanged for cash. The major advantage of using Emoney is transactions within the network are cashless and it is being used to promote the strengthening of business amongst members within the network. As the financial accountant you have been asked about the impact this will have on the financial position of the business, any risks involved and how the virtual currency should be recognised from an accounting point of view by writing a report for the Chief Financial Controller (CFO). Required: Write a 750 – 1000 word report that addresses the following criteria: 1. With reference to the Framework for the Preparation and Presentation of Financial Statements (Conceptual Framework) justify whether Emoney satisfies the definition and recognition criteria of an asset. 2. With reference to any appropriate accounting standards justify what is the correct initial accounting treatment for recording the value of Emoney. 3. Upon initial classification discuss the subsequent accounting treatment with respect to the initial classification. 4. Discuss any risks associated with the recognition of Emoney and the relevance this has for the accounting treatment. Where any reference is made to the accounting standards, the framework, textbooks etc it needs to be appropriately referenced. Please note APA referencing style is to be used. Your report should be structured and include the following: Cover Sheet Executive Summary Introduction Body of the Report Conclusion References Please note your report must be referenced. (APA referencing style is to be used). Page 3 of 4 Marking Criteria: Criteria Marks Excellent Satisfactory Poor 100% 75% 74% 50% 49% 0% The E Dollar Justification why E Money meets the definition of an asset with reference to the Framework 6 Comprehensive justification and demonstrated understanding as to why EMoney meets the definition and recognition criteria of an asset is provided with reference to the Framework. Logic and reasoning of argument is excellent Limited justification and understanding as to why the E Money meets the definition and recognition criteria of an asset is provided with reference to the Framework. Logic and reasoning of argument is satisfactory due to limited justification No justification or incorrect justification or understanding as to why EMoney meets the definition and recognition criteria of an asset is provided with reference to the Framework. Logic and reasoning of argument is poor due to no or limited justification. Discussion and analysis of the initial treatment of E Money 5 Thorough/deep and relevant discussion provided as to the accounting treatment of EMoney with reference to the application of the appropriate accounting standard. Logic and reasoning of argument is excellent Limited discussion (either lacks relevance or depth) provided as to the accounting treatment of the E Money with reference to the application of the appropriate accounting standard. Logic and reasoning of argument is satisfactory due to limited justification None or incorrect discussion provided as to the accounting treatment of the E Dollar with reference to the appropriate accounting standard. Logic and reasoning of argument is poor due to no or limited justification Subsequent accounting treatment 3 Subsequent accounting treatment with reference to the appropriate accounting standard is thoroughly discussed, relevant and accurate. Logic and reasoning of argument is excellent Subsequent accounting treatment with reference to the appropriate accounting standard is discussed to a limited extent and/or is partially correct and/or partially relevant. Logic and reasoning of argument is satisfactory due to limited justification Subsequent accounting treatment with reference to the appropriate accounting standard is not discussed, incorrect and/or very limited and/or irrelevant. Logic and reasoning of argument is poor due to no or limited justification Risks involved with Emoney and relevance this has for the accounting treatment. 2 Risks associated with use of Emoney are thoroughly discussed, relevant and accurate. Risks associated with use of Emoney are discussed to a limited extent and/or are partially relevant and/or partially correct. Risks associated with use of Emoney are not discussed, are discussed superficially, and/or are incorrect and/or are not discussed and/or are not relevant. Page 4 of 4 The Report Presentation of the report 2 The report is well presented with consistent use of formatting, headings, subheadings and supporting tables/graphics. The formatting and layout of the report is inconsistently presented. Inconsistent use of formatting, headings and supporting tables/graphics The formatting and layout is poor indicating a lack of professionalism. Either appropriate headings are not used and/or there is a lack of formatting and/or there is a lack of supporting tables/graphics Structure, Quality of Writing and Referencing 2 Referencing appropriate with no errors or omissions. Professional language is used which communicates meaning with clarity and fluency. No errors in spelling, grammar and punctuation, or sentence structure. An adequate attempt at referencing was made with minor errors or omissions in the style of referencing. Adequate language which conveys meaning with some clarity, however there the report is inconsistent in its flow from one idea to the next and there are errors in expression. Errors in spelling, grammar, punctuation, sentence structure, and/or organisation Lack of proper referencing. Either references are missing or the referencing style has not been applied accurately Poor language impedes meaning because of errors in usage and disorganisation of information. Consistent errors in spelling, grammar, punctuation, sentence structure and/or organisation. Total Marks 20
ransaction 1:Assume a nonprofit has a restricted fund for capital asset purchases. Compare the journal entries for the cash purchase of a $10,000 computer by the nonprofit, to how the journal entry would look for this for profit.
Transaction 2:Assume that a nonprofit has a need for $80,000 for a particular new marketing expenditure, and a for profit entity needs to raise an additional $80,000 to pay for some unanticipated marketing expenses. How would the journal entities look at the acquisition of the funds and the subsequent spending of the funds?
Transaction 3:The for profit entity sells $120,000 with net 30 day terms, while the nonprofit entity has a fund raising drive for which they receive pledges of $120,000. How do the two journal entries look?
Interest 150,000 Other 80,000 In addition, the Inn’s pretax income will be taxed at an average tax rate of 25 percent. Required:
1. What is the monthly breakeven level of sales at the German Inn? 2. What amount of annual sales are required if the owners are to earn 20 percent of their investment in this property?
Problem 6
The Double A Inn, owned by Alex and Andy Roof, includes a 40 room lodging operation and coffee shop. The average annual revenue and variable expense figures for the past two years have been as follows:
Rooms Café Shop Revenue $ 600,000 $ 400,000 Variable expenses 120,000 200,000 The fixed costs are as follows: Rooms department $50,000 Coffee shop 60,000 Overhead 300,000
Required: 1. Assuming the sales mix remains constant, calculate the following: a. The annual revenue at the breakeven point. b. Total net income when total revenue equals $1,200,000. (Assume an income tax of 20 percent.) c. The required level of annual revenue when net income is $200,000. (Assume there are no income taxes.) 2. Answer the same questions as Part 1, but assume the sales mix has changed to 75 per cent/25 percent for rooms/coffee shop.
Problem 7
John Rhoades, owner of Rhoades Inn, has requested your assistance in analyzing his 50 room rooms only property. He provides you information as follows: 1. The average rooms sales price is $30. 2. Monthly fixed costs equal $20,000. 3. His variable costs per room sold equal $10.
Management Accounting BAP22ACase Studies Semester 3, 2013Management AccountingBAP22AGROUPsAand EThe French pastry company makes a range of delicious cakes and pastries. Their website shows the following information about the company’s history:The business began in 1990, with three product lines –croissants, fruit tarts and eclairs. The products were very successful and we sold everything we could produce, using hard work and simple machinery.Today, we still make and sell a lot of croissants and eclairs, but we also produce a wide range of low volume lines such as fruit danishes, snails, and friands. These products are more complicated to produce and have shorter production runs, so that there is more set up time for the machinery and more material handling. We have introduced computerised mixing machines and ovens which have replaced a lot of direct labour in our factory, and we are focussing more on delivery and quality to meet our customers’ requirements.You have recently been hired as the management accountant for the businessdue to the retirement of the previous management accountant, who had been with the business since it began operations. When you look at the results, the company’s profits have been declining over recent years. However, the product profitability analysis for the specialty lineson fruit danished, snails and friands shows that they are profitable. You wonder if there is a problem with the product costing system which the French pastry company is using. When you talk to the manufacturing supervisors and managers, they also believethat the product costing system is distorting the costs.Required:1)Using the information given above, describe the changes in cost structure which would have occurred at the company over the last 20 years, and explain their causes2)Do you think the existing costing systems overstate or understate the cost of producing a.Croissants Management Accounting BAP22ACase Studies Semester 3, 2013b.Snails3)Explain how activity based costing could overcome the deficiencies in the existing costing system4)After many meetings with manufacturing staff, you have identified the activity centres in the business, and collected information about some activity drivers. Identify the best activity (cost) driver for each activity centre,and prepare notes on why you have selected each driver to explainyour choices to managers in your next meeting.Cost CategoryCostCost DriverWages300,000$ No of employeesBuilding Costs80,000$ Floor spaceDepreciation100,000$ Machine hoursConsumables50,000$ Orders placedEnergy400,000$ KwH usedOther20,000$ No of employeesTotal950,000$ Activity CentresEmployeesBuilding sqmMachine HoursOrdersKwHProduct Development520010Sales and Dispatch1050015Mixing155001,0005010,000Filling201,0003,00010010,000Baking155005,000100200,000Packing201,00050015030,000Administration101,00050050Corporate Management530025Total1005,00010,000500250,0005)Use activity based costing to develop the cost for each activity centre.
Basil arrived in Australia on 28 August 2013 from his usual domicile in England. He obtained a working visa that permits him to work in Australia for three years. He is a specialist in information technology and is employed by Systems Ltd, a resident UK company that has secured a contract in Australia. His wife Sybil and two school aged children accompany him. For the present he proposes to rent accommodation in Adelaide but he may buy a property if he likes the country and spots a real estate bargain.
Basil is paid a base salary of $12,000 per month plus a rent subsidy of $600 per month. Half of the net (after tax) salary is credited to an Adelaide bank account, the balance to an account at the Bank of England. He is also provided with a fully maintained motor vehicle for his private use. His employer pays half his phone account. The amounts are $A125, $A460, $A440 and $A475 in September, December, March and June, respectively.
His England home, owned jointly with his wife Sybil, is rented out for $A800/month, in advance on the 1 st of every month, and paid into the England bank account. Each quarter, interest is credited to the bank account in the joint names of Basil and Sybil.
In December 2013 Basil received a performance award from his employer consisting of a fully paid trip for the family to Hong Kong. The trip is valued at $A10,000, is non transferable and must be taken before August 2014. It has not been taken by June 30, 2014.
In October 1990 Basil acquired a parcel of speculative shares in an English company for $A14,000. The price had not changed for some time and then in March 2014 suddenly jumped to $A23,000 and Basil sold the shares immediately. In November 2013 he purchased Australian shares for $8,250 and sold them in April 2014 for $6,400.
At an auction in Adelaide in December 2013 he purchased four dining chairs that Sybil liked. The total price was $550. Later, a friend visiting their house saw the chairs and was sure they were Queen Anne antiques. He contacted a collector who inspected the chairs and offered Basil $14,000 for the set.
Required:
Is Basil a resident of Australia for tax purposes? [You should consider the definition in ITAA36 s6(1), the evidence and the leading authorities (Applegate and Jenkins cases).] Suggested maximum: 500 words.
Assume Basil is an Australian resident. Advise him of his tax position and the assessability of the following:
Salary and rent subsidy
Motor vehicle, phone account and holiday
English rent
English shares and Australian shares
Chairs.
Part B [Approx 1/3 rd of marks]
Family Value Stores [FVS] is a large department store in a Melbourne. Sales are made on the following terms:
Cash;
Lay by;
By what is called “take now; pay later”.
Required 1
Under the Lay by sales conditions customers pay a non refundable deposit of 10% and agree to pay off the balance within 12 months. The goods are taken from the store’s inventory and set aside at the time the deposit is made.
Should FVS return on a cash or accrual basis? Cite relevant case law.
When is income derived in a lay by sale?
What is the tax treatment of a) the deposit; and b) progress payments?
What is the tax treatment of the trading stock the subject of a lay by?
Required 2
Under the ‘take now, pay later’ contract customers pay a 10% deposit and may take the goods on condition that a further 8% of the sale price is added to the balance owing which the customer then pays off in 12 equal monthly instalments. [See example] The contract notes that title passes to the customer at the time of sale and, if the customer defaults on any payment, the whole debt is immediately payable and recoverable.
Example: List price $3000; deposit $300; balance $3000 + (3000 x 8%) 240 – 300 = $2940/12 = $245 per month. [Total paid: $3,240]
For the year ended June 30 records show sales of $1,125,000:
Questions must me answered from the perspective of the theories discussed in the subject. Providing a summary of the case without any discussion of the theory will not fetch marks.
The assignment must be provided with a cover paper mentioning the name and student numbers of the group members
Assignment is to submitted on Moodle.Only one students submits the assignment in Moodle which must include the cover page
Case Study Question 1 (20 marks) (500 words)
Read headline “Health rates as top social issue”. Would you expect management to worry about attitudinal surveys, such as the one described in Headline below. Explain you answer, as well explaining how such surveys might impact on the disclosure policies of an organisation.
CANBERRA: Health has taken over from crime as the most important social issue seen to be facing Australia, figures showed yesterday.
The survey of people’s views of environmental issues found the environment rated fifth in importance even though three in four Australians had at least one environment concern.
The Australian Bureau of Statistics (ABS) figures showed 29% of respondents believed health was the most important social issue.
This was followed by crime (24%) education and unemployment (both 16%) and environmental problems (16 %).
In 1996, crime was seen as the most important social issue, followed by health, education, unemployment, the environment.
In the latest survey, dated March 1998, health was the most important issue to older people and least important to people aged 35 44.
In general, younger people were more concerned about long term environmental problems although 19 24 year olds, as well as 45 54 year olds were most concerned about unemployment.
But the survey said 71% of Australians were concerned with at least one specific environmental problem.
The figure was up from 68% in 1996 but down from 75% in 1992.
People living in ACT were most concerned while Tasmanians were the least concerned about environmental problems.
Air pollution continued to be the problem of greatest worry for Australians, with 32% reporting it as their major concern.
The Chronicle,
Case Study Question 2 (20 marks) 500 words
Read headline “Think before you spend”and then, drawing on material covered in this subject, Accounting Theory, identify some ways in which you think corporations would respond to such allegations.
Here are some of the products “The Rough Guide to Ethical Shopping” believes we should think about before buying:
Beverages: Maxwell House. One of the thousands of familiar brands Bird’s, Jacobs, Ritz and Toblerone are others owned by tobacco giant Philip Morris of Marlboro cigarette fame, which recently changed its name to Altria.
It denies to this day that smoking is addictive, was fined for failing to disclose political donations and was one of George Bush’s largest corporate campaign contributors.
Clothing: Nike trainers. Nike is said to have petitioned the Indonesia government for exemption from the minimum wage and has been accused of lying about labour conditions at its contractor factories.
According to Sweatshop Watch, an average Nike worker would need to put in 72,000 years of work to receive what Tiger Woods gets for one five year contract to publicise the brand.
Food: Tiger prawns. Hugely popular nowadays in restaurants and supermarkets, tiger prawns are mostly raised in man made pools in Bangladesh and the Philippines.
It takes 50,000 litres of water to produce a kilogram of prawn meat and the chemical additives to promote rapid growth ends up polluting the surrounding farming land.
People are routinely displaced to make way for these farms. Rape and murder have been reported in some cases.
Sport: Snooker cues. Thousands of snooker cues are made every year using wood from the Indonesian ramin tree. The ramin, which is also used for furniture and window blinds, is a rare and endangered tree listed under the Convention on International Trade in Endangered Species, but continues to be logged illegally at an alarming rate.
(Irish Independent, 1 December 2004, Independent Newspapers Ireland Ltd)
CASE STUDY QUESTION 3 (20 MARKS) 500 words
Read headline “Lay off Big Macs, radio boss tells staff” and using Legitimacy Theory as the basis of your argument, explain why a company such as McDonald’s would not want a radio station to make adverse comments about it. If the station does make adverse statements, how might McDonald’s react from a corporate disclosure perspective?
Top management at radio 2UE ordered the station’s broadcaster not to make derogatory comments about McDonald’s on air or the station would lose its $170,000 advertising account with the fast food chain, according to a leaked in internal memo.
The memo from program director John Brennan in February reveals for the first time that the practice of tailoring editorial comment to suit 2UE’s advertisers in an internal part of the top rating radio station’s culture.
‘It’s going to be a tough year for revenue and we need all the help we can get from everyone concerned’ the management memo says.
‘It is obviously imperative that no derogatory comments about McDonald’s are made be any broadcaster on the station. Any such comment would see an immediate cancellation of the contract’
The memo will be investigated by the Australian Authority’s inquiry into the radio station next month.
Mr Brennan’s directive appears to contravene the Commercial Radio Code of Practice, under which a radio must promote accuracy and fairness in news and current affairs programs. The code may be reviewed by the ABA in separate public hearings and may result in moves away from self regulation.
The memo contradicts statements by 2UE chief John Conde this week about the role of station management in the scandal involving John Laws and the now defunct $1.2 million deal with Australian Bankers’ Association.
The banks’ deal with Laws also involved refraining from negative comments about the client on air.
McDonald’s spokesman John Blyth said the company was unaware the 2UE directive had issued and would never make its advertising contracts conditional on editorial comment.
The memo was addressed to Alan Jones, John Laws, John Stanley, Mike Carlton, Peter Bosly, Ray Hadly, Stan Zemanek and eight other on air presenters.
Senior management was also party to the directive.
In a letter to the Australian yesterday, Mr Conde confirmed Mr Brennan wrote the memo, which had ‘reflected (his) exuberance’. He said Mr Brennan had promptly clarified the memo, telling staff he only intended to avoid any announcer ‘sending up’ the McDonald’s ads. ‘It was made plain 2UE was not seeking to curtail editorial comment’
In a separate statement, Mr Conde said 2UE and its affiliates were to receive $707,000 from the
Presented below are selected accounts for Salazar Company as reported in the worksheet using a perpetual inventory system at the end of May 2014.
Accounts
Adjusted Trial Balance
Income Statement
Balance Sheet
Cash
11,000
Inventory
76,000
Sales Revenue
480,000
Sales Returns and Allowances
10,000
Sales Discounts
9,000
Cost of Goods Sold
300,000
Instructions
Complete the worksheet by extending amounts reported in the adjusted trial balance to the appropriate columns in the worksheet. Do not total individual columns.
Presented below are selected accounts for B. Midler Company as reported in the worksheet at the end of May 2014. Ending inventory is $75,000.
Accounts
Adjusted Trial Balance
Income Statement
Balance Sheet
Cash
9,000
Inventory
80,000
Purchases
240,000
Purchase Returns and Allowances
30,000
Sales Revenue
450,000
Sales Returns and
Allowances
10,000
Sales Discounts
5,000
Rent Expense
42,000
Instructions
Complete the worksheet by extending amounts reported in the adjustment trial balance to the appropriate columns in the worksheet. The company uses the periodic inventory system.
Powell”s Book Warehouse distributes hardcover books to retail stores and extends credit terms of 2/10, n/30 to all of its customers. At the end of May, Powell”s inventory consisted of books purchased for $1,800. During June, the following merchandising transactions occurred.
June
1
Purchased books on account for $1,600 from Kline Publishers, FOB destination, terms 2/10, n/30. The appropriate party also made a cash payment of $50 for the freight on this date.
3
Sold books on account to Reading Rainbow for $2,500. The cost of the books sold was $1,440.
6
Received $100 credit for books returned to Kline Publishers.
9
Paid Kline Publishers in full, less discount.
15
Received payment in full from Reading Rainbow.
17
Sold books on account to Blanco Books for $1,800. The cost of the books sold was $1,080.
20
Purchased books on account for $1,500 from Dietz Publishers, FOB destination, terms 2/15, n/30. The appropriate party also made a cash payment of $50 for the freight on this date.
24
Received payment in full from Blanco Books.
26
Paid Dietz Publishers in full, less discount.
28
Sold books on account to Reddy Bookstore for $1,400. The cost of the books sold was $850.
30
Granted Reddy Bookstore $120 credit for books returned costing $72.
Powell”s Book Warehouse”s chart of accounts includes the following: No. 101 Cash, No. 112 Accounts Receivable, No. 120 Inventory, No. 201 Accounts Payable, No. 401 Sales Revenue, No. 412 Sales Returns and Allowances, No. 414 Sales Discounts, and No. 505 Cost of Goods Sold.
Instructions
Journalize the transactions for the month of June for Powell”s Book Warehouse using a perpetual inventory system.
Latona Hardware Store completed the following merchandising transactions in the month of May. At the beginning of May, the ledger of Latona showed Cash of $5,000 and Owner”s Capital of $5,000.
May
1
Purchased merchandise on account from Gray”s Wholesale Supply $4,200, terms 2/10, n/30.
2
Sold merchandise on account $2,100, terms 1/10, n/30. The cost of the merchandise sold was $1,300.
5
Received credit from Gray”s Wholesale Supply for merchandise returned $300.
9
Received collections in full, less discounts, from customers billed on sales of $2,100 on May 2.
10
Paid Gray”s Wholesale Supply in full, less discount.
11
Purchased supplies for cash $400.
12
Purchased merchandise for cash $1,400.
15
Received refund for poor quality merchandise from supplier on cash purchase $150.
17
Purchased merchandise from Amland Distributors $1,300, FOB shipping point, terms 2/10, n/30.
19
Paid freight on May 17 purchase $130.
24
Sold merchandise for cash $3,200. The merchandise sold had a cost of $2,000.
25
Purchased merchandise from Horvath, Inc. $620, FOB destination, terms 2/10, n/30.
27
Paid Amland Distributors in full, less discount.
29
Made refunds to cash customers for defective merchandise $70. The returned merchandise had a fair value of $30.
31
Sold merchandise on account $1,000 terms n/30. The cost of the merchandise sold was $560.
Latona Hardware”s chart of accounts includes the following: No. 101 Cash, No. 112 Accounts Receivable, No. 120 Inventory, No. 126 Supplies, No. 201 Accounts Payable, No. 301 Owner”s Capital, No. 401 Sales Revenue, No. 412 Sales Returns and Allowances, No. 414 Sales Discounts, and No. 505 Cost of Goods Sold.
Instructions
(a) Journalize the transactions using a perpetual inventory system.
(b) Enter the beginning cash and capital balances and post the transactions. (Use J1 for the journal reference.)
(c) Prepare an income statement through gross profit for the month of May 2014.
Schwinn Manufacturing Company manufactures a variety of garden and lawn equipment. The company operates through three divisions. Each division is an investment center. Operating data for the Lawnmower Division for the year ended December 31, 2010, and relevant budget data are as follows.
Actual
Comparison with Budget
Sales
$2,900,000
$120,000 unfavorable
Variable cost of goods sold
1,400,000
90,000 unfavorable
Variable selling and administrative expenses
300,000
50,000 favorable
Controllable fixed cost of goods sold
270,000
On target
Controllable fixed selling and administrative
expenses
140,000
On target
Average operating assets for the year for the Lawnmower Division were $5,000,000 which was also the budgeted amount.
Instructions
(a) Prepare a responsibility report (in thousands of dollars) for the Lawnmower Division.
(b) Evaluate the manager’s performance.Which items will likely be investigated by top management?
(c) Compute the expected ROI in 2011 for the Lawnmower Division, assuming the following independent changes.
(1) Variable cost of goods sold is decreased by 15%.
(2) Average operating assets are decreased by 20%.
(3) Sales are increased by $500,000 and this increase is expected to increase contribution margin by $210,000.
Problem 1 Matador Inc. sells computer monitor screens. The direct labor (DL) rate includes wages, benefits and payroll tax. Direct materials cost is $10 per unit. Beginning inventory is 10,000 screens and policy is to carry 50% of the following months projected sales in inventory. Data from the company is below. Month Jan Feb Mar Apr Estimated Sales in units 20,000 24,000 16,000 18,000 Sales Price/unit $80 $80 $75 $75 DL hours/unit 4 4 3.5 3.5 DL hourly rate $15 $15 $16 $16 a) Prepare the following budgets for the first quarter. Show your calculations. 1) Production Budget; 2) DL hours required; 3) Direct materials usage budget; 4) Revenue budget. b) Calculate the total budgeted contribution margin for the first quarter. Show your calculations. Problem 2 Torrence Company has two support departments (Administration and Janitorial) and three producing departments (Fabricating, Assembly, and Finishing). Costs and activities are as follows: Administration Janitorial Fabricating Assembly Finishing Direct costs $50,000 $30,000 $40,000 $50,000 $25,000 Number of employees 10 30 40 20 Square feet 2,000 10,000 28,000 15,000 Direct labor hours 5,000 6,000 2,000 Administrative services are allocated based on the number of employees; janitorial services are allocated based on square footage. Overhead rates for the three producing departments are based on direct labor hours. a) Determine the total cost allocation and departmental overhead rate for the producing departments using the direct method. Show your work. b) Determine the total cost allocation and departmental overhead rate for the producing departments using the step down method. Show your work. Problem 3 Comfy Chair Company makes two types of chairs, a lounge chair and a folding beach chair. The company uses a job order costing system and applies overhead on the basis of direct labor hours. Comfy Chair expects to produce 40,000 lounge chairs and 100,000 beach chairs next year. Comfy Chair has been considering changing to an activity based costing system. The company has reported the following results from the first stage cost allocations for a year’s production: Overhead Cost Activities by Product Activity Assigned Lounge Chairs Beach Chairs Labor related $300,000 100,000 DLHrs 200,000 DLHrs Machine related $450,000 30,000 MHrs 60,000 MHrs Machine setups $730,000 4,000 Setups 1,000 Setups Order processing $600,000 4,500 Orders 1,500 Orders General factory $500,000 Direct Labor $2,000,000 DL$ $3,000,000 DL$ Direct Materials $3,200,000 DM$ $1,000,000 DM$ a) Determine the total cost per unit for each product using traditional job order costing. Show your work. b) Determine the total cost per unit for each product using activity based costing. Show your work. c) Comment on the differences between the two.
Discuss the revenue principle and the matching principle as per the generally accepted accounting principles (GAAP).
Contrast the percentage of completion method of revenue recognition versus the completed contract method.
Solve this accounting problem for the ABC grocery company relating to revenue and expense recognition as per GAAP: ABC Corporation uses the percentage of completion method of accounting. In 2010, ABC entered into a contract for a contract price of $2,000,000.
2010
Costs incurred during the year
600,000
Estimated costs to complete as of Dec 31
900,000
Billings during the year
400,000
Collections during the year
300,000
What portion of the total contract price is recognized as revenue in 2010?
What is the profit recognized for 2010?
Prepare the journal entries for 2010 under the percentage completion method.
Visit the website of the IASB (www.ifrs.org) and the AASB (www.aasb.com.au)
Required
A . Find our the major issues currently on the agenda for consideration in future accounting standards, and present a report to the class on the basic requirements of those standards.
B . Determine and report to the class on the latest issues being discussed by the IASB and the FASB in their joint project of revising the conceptual framework.
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TOPIC International issues in Accounting Future consideration Visit the website of the IASB (? HYPERLINK “http://www.ifrs.org” ?www.ifrs.org?) and the AASB (? HYPERLINK “http://www.aasb.com.au” ?www.aasb.com.au?) Required A . Find our the major issues currently on the agenda for consideration in future accounting standards, and present a report to the class on the basic requirements of those standards. B . Determine and report to the class on the latest issues being discussed by the IASB and the FASB in their joint project of revising the conceptual framework.
The 2013 financial statements for Armstrong and Blair companies are summarized here:
The companies are in the same line of business and are direct competitors in a large metropolitan area. Both have been in business approximately 10 years, and each has had steady growth. One third of both companies’ sales are on credit. Despite these similarities, the management of each has a different viewpoint in many respects. Blair is more conservative, and as its president said, “We avoid what we consider to be undue risk.” Both companies use straight line depreciation, but Blair estimates slightly shorter useful lives than Armstrong. No shares were issued in 2013, and neither company is publicly held. Blair Company has an annual audit by a CPA but Armstrong Company does not. Assume the end of year total assets and net property and equipment balances approximate the year’s average.
Copy the above information for both companies into an excel spreadsheet. Using exhibit 13.5 in the text (page 613), complete the ratios ( Ignore Ratios 13 )
The ratios should be calculated by referencing the cells in the financial statements. Round all calculations to two decimal places. More info below
Compute ratios (link numbers used for ratios to summary of financial statements) Page 613 of the text has all the formulas. You can copy the functions for one company to the other company, reducing your time and effort. Since both companies Armstrong and Blair are in the same industry, please indicate which ratio is generally more favorable. For each ratio, I need a definition of what is being analyzed. page 613 will refer you to the chapter and page where you can get this information
TIP: To calculate EPS, use the balance in Common Stock to determine the number of shares outstanding. Common Stock equals the par value per share times the number of shares.
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Excel Assignment #2??The 2013 financial statements for Armstrong and Blair companies are summarized here: The companies are in the same line of business and are direct competitors in a large metropolitan area. Both have been in business approximately 10 years, and each has had steady growth. One third of both companies’ sales are on credit. Despite these similarities, the management of each has a different viewpoint in many respects. Blair is more conservative, and as its president said, “We avoid what we consider to be undue risk.” Both companies use straight line depreciation, but Blair estimates slightly shorter useful lives than Armstrong. No shares were issued in 2013, and neither company is publicly held. Blair Company has an annual audit by a CPA but Armstrong Company does not. Assume the end of year total assets and net property and equipment balances approximate the year’s average. Copy the above information for both companies into an excel spreadsheet. Using exhibit 13.5 in the text (page 613), complete the ratios (Ignore Ratios 13 ) The ratios should be calculated by referencing the cells in the financial statements. Round all calculations to two decimal places. More info below Compute ratios (link numbers used for ratios to summary of financial statements) Page 613 of the text has all the formulas. You can copy the functions for one company to the other company, reducing your time and effort. Since both companies Armstrong and Blair are in the same industry, please indicate which ratio is generally more favorable.??For each ratio, I need a definition of what is being analyzed. page 613 will refer you to the chapter and page where you can get this information TIP: To calculate EPS, use the balance in Common Stock to determine the number of shares outstanding. Common Stock equals the par value per share times the number of shares.
The ledger of Rios Company contains the following balances: Owner’s Capital $30,000; Owner’s Drawings $2,000; Service Revenue $50,000; Salaries and Wages Expense $27,000; and Supplies Expense $7,000. The closing entries are as follows:
(1)
Close revenue accounts.
(2)
Close expense accounts.
(3)
Close net income/(loss).
(4)
Close drawings.
Post the closing entries in the order presented in the problem and use the numbers as a reference.
I need help for my Taxation assignment. Its 2000 words assignment.
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The Faculty of Business BULAW 5916 Taxation Law & Practice Assignment: Semester 1/2014 INSTRUCTIONS See the Instructions and Assessment Criteria in the Course Description and make sure you follow them! Please answer all parts of the question Attached to this document is a Checklist to be filled in by you and attached to your essay/assignment. Read this now before you start your research. If you have followed this checklist, there is a good chance you will do well. All work presented for assessment in this course must comply with the format outlined in the University’s Presentation of Academic Work publication, available from the bookshop or on line at ? HYPERLINK “http://www.ballarat.edu.au/generalguide” ?www.ballarat.edu.au/generalguide?. All essays must be accompanied by a signed official cover sheet (‘Plagiarism Declaration Form’), available at www.ballarat.edu.au/ard/business/student_info_webct.shtml and lodged as appropriate for your campus. You MUST reference in the body of the essay every time you use information from other people. This requires you to keep a track of where you are taking information from and then writing the reference up. You should use the Harvard/APA style; and use the University’s new Presentation of Academic Work. The Library’s website also has a citation style guide site. If you plagiarise (intentionally OR unintentionally) you will be given zero: see Regulation 6.1.1 for more details. DUE DATE:……. Please check with the Course Description for details of where and when to submit your assignment. If you need an extension you must ask for one BEFORE the due date (unless this is impossible). The assignment should not exceed approximately 2000 words. The assignment is worth 25%. Part A [Approx 2/3rd of marks] Basil arrived in Australia on 28 August 2013 from his usual domicile in England. He obtained a working visa that permits him to work in Australia for three years. He is a specialist in information…
As the External Auditor and using a standard format memo (i.e. a short report of ½ to 1 ½
pages
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Holmes Institute HI5025 Memo 02 – Semester 01, 2014 Background: Mr David Buttoner the owner operator of Buttons by David Pty Ltd. runs a number of button lines. His favourite is a cut stag horn button that has gold filigree. Using a variable costing approach, the revenues and costs per 100 buttons is: Table 1: Stag Horn Button Costs per 100 Buttons Sales Revenue $200.00 VC of materials – Stag horn $40.00 – Gold wire 50.00 $90.00 VC of labour – Cutting $ 5.00 – Wire inlay 35.00 – Polishing 8.00 48.00 VC of MO/H – Indirect Materials $ 2.00 – Indirect Labour 5.00 – Other MO/H 15.00 22.00 VC of SG&A 5.00 $165.00 Contribution Margin $ 35.00 FC of MO/H $ 100.00 FC of SG&A 25.00 $125.00 Profit/(loss) before Taxes ($90.00) However, that line is not popular with the customers and generates a substantial loss for the company. Currently, the company has 30,000 stag horn buttons in inventory. Required: As the External Auditor and using a standard format memo (i.e. a short report of ½ to 1 ½ pages) please explain to Mr David Buttoner: 1) The concept of valuing Inventories at the “Lower of Cost or Market” (cite the AASB Handbook section), 2) The estimated “full absorption cost” of manufacturing 100 stag horn buttons, and 3) The appropriate value for the stag horn buttons inventory in total and per 100 buttons – show calculations to justify your answer. This is to be answered in your groups of 3 6 students, where each group will submit one report with the names and student numbers of all group members in the heading. The assignment is due 14 May/14, in class. The marking rubric that will guide the marking is posted to the assignment section of the HI5025 Blackboard site.
Name:???Acct 220.Se14 Final Exam Problem 1: Suggested time 20 minutes: 15% points a. Adjusting Entries: Date?Account?Debit?Credit??????????????????????????????????????????????????????????????b. Partial Adjusted Trial Balance: ??Adjusted Trial Balance (partial)????Account Titles?Debit?Credit??Prepaid Insurance????Supplies????Accumulated Depreciation, Equipment????Accounts Payable????Flap’s Drawings????Service Revenue????Depreciation Expense, Equipment????Supplies Expense????Insurance Expense????Rent Expense????Utilities Expense???? Answer Sheet Page 1 of 6.Se14 Final Exam c. Closing Entries: Date?Account?Debit?Credit??????????????????????????????????????????????????????????????????????????????????Problem 2: Suggested time 15 minutes: 15% points a. Cost of Goods Available for Sale???b. Value of:?Ending Inventory?COGS?? (1) LIFO method???? (2) FIFO method???? (3) Average cost method????Show calculations in this text entry box: ?? Answer Sheet Page 2 of 6.Se14 Final Exam Problem 3: Suggested time 20 minutes: 15% points ??????????This document was truncated here because it was created in the Evaluation Mode.
Sedato Company follows the practice of pricing its inventory at the lower of cost or market, on an individual item basis.
Item No.
Quantity
Cost per Unit
Cost to Replace
Estimated Selling Price
Cost of Completion and Disposal
Normal Profit
1320
1,500
$5.86
$5.49
$8.24
$0.64
$2.29
1333
1,200
4.94
4.21
6.22
0.92
0.92
1426
1,100
8.24
6.77
9.15
0.73
1.83
1437
1,300
6.59
5.67
5.86
0.82
1.65
1510
1,000
4.12
3.66
5.95
1.46
1.10
1522
800
5.49
4.94
7.14
0.73
0.92
1573
3,300
3.29
2.93
4.58
1.37
0.92
1626
1,300
8.60
9.52
10.98
0.92
1.83
From the information above, determine the amount of Sedato Company’s inventory.
Question 2
On March 10, 2014, No Doubt Company sells equipment that it purchased for $352,800on August 20, 2007. It was originally estimated that the equipment would have a life of12years and a salvage value of $30,870at the end of that time, and depreciation has been computed on that basis. The company uses the straight line method of depreciation.
Compute the depreciation charge on this equipment for 2007, for 2014, and the total charge for the period from 2008 to 2013, inclusive, under each of the six following assumptions with respect to partial periods. (Round answers to 0 decimal places, e.g. $45,892.)
2007
2008 2013 Inclusive
2014
(1)
Depreciation is computed for the exact period of time during which the asset is owned. (Use365days for the base.)
$
$
$
(2)
Depreciation is computed for the full year on the January 1 balance in the asset account.
$
$
$
(3)
Depreciation is computed for the full year on the December 31 balance in the asset account.
$
$
$
(4)
Depreciation for one half year is charged on plant assets acquired or disposed of during the year.
$
$
$
(5)
Depreciation is computed on additions from the beginning of the month following acquisition and on disposals to the beginning of the month following disposal.
$
$
$
(6)
Depreciation is computed for a full period on all assets in use for over one half year, and no depreciation is charged on assets in use for less than one half year.
$
$
$
Question 3
Santana Company exchanged equipment used in its manufacturing operations plus $3,990in cash for similar equipment used in the operations of Delaware Company. The following information pertains to the exchange.
Santana Co.
Delaware Co.
Equipment (cost)
$55,860
$55,860
Accumulated depreciation
37,905
19,950
Fair value of equipment
26,933
30,923
Cash given up
3,990
(a) Prepare the journal entries to record the exchange on the books of both companies. Assume that the exchange lacks commercial substance. (Credit account titles are automatically indented when amount is entered. Do not indent manually.)
No.
Account Titles and Explanation
Debit
Credit
(a)
Santana Company:
(b)
Delaware Company:
(b) Prepare the journal entries to record the exchange on the books of both companies. Assume that the exchange has commercial substance. (Credit account titles are automatically indented when amount is entered. Do not indent manually.)
In this assessment, you will apply the concept of transfer pricing to divisions within a CPA firm. You will draw on your knowledge of cost and revenue centres, and performance management.
You may work independently on this assessment, or in teams of 2 or 3. Please use your learning group discussion forum to choose a group, and advise your eLA.
Assessment details
Smith and Nguyen is a rapidly expanding CPA firm of public accounting practitioners. Offices are located in each capital city in Australia, and the firm has recently established an office in London.
Each office is organised into four divisions, Audit, Taxation, Business Consulting, and Staff Training. Each division derives revenue from client fees, except staff training — which is currently a cost centre.
Brian Smith is the senior staff partner. He is optimistic that in 2013 the firm will continue to achieve growth. However, in order to enhance profitability following the economic slow down in the European market, Brian believes greater cost control is necessary.
Brian is particularly anxious regarding the performance of staff training. The commitment in 2013 to this division is $1,150,000 fixed salary cost and $210,000 variable cost. The division is not operating at full capacity. Under the present system, staff training consists of regular weekly sessions for staff involved in the CPA programme, as well as seminars designed to update all staff in the current developments in accounting, audit and taxation.
Brian is proposing that motivation and ultimately performance would be improved by considering staff training as a profit centre. Each of the three divisions would be charged an hourly rate for the service which would represent revenue to the training division.
This table shows the use of training hours by each division for employees during the past two years (2011 and 2012) with the expected hours for the budgeted year of 2013 in the final column.
ASSIGNMENT: FINANCIAL ACCOUNTING THEORY This is a group assignment of maximum 3 students. Questions must me answered from the perspective of the theories discussed in the subject. Providing a summary of the case without any discussion of the theory will not fetch marks. The assignment must be provided with a cover paper mentioning the name and student numbers of the group members Assignment is to submitted on Moodle.Only one students submits the assignment in Moodle which must include the cover page Case Study Question 1 (20 marks) (500 words) Read headline “Health rates as top social issue”. Would you expect management to worry about attitudinal surveys, such as the one described in Headline below. Explain you answer, as well explaining how such surveys might impact on the disclosure policies of an organisation. CANBERRA: Health has taken over from crime as the most important social issue seen to be facing Australia, figures showed yesterday. The survey of people’s views of environmental issues found the environment rated fifth in importance even though three in four Australians had at least one environment concern. The Australian Bureau of Statistics (ABS) figures showed 29% of respondents believed health was the most important social issue. This was followed by crime (24%) education and unemployment (both 16%) and environmental problems (16 %). In 1996, crime was seen as the most important social issue, followed by health, education, unemployment, the environment. In the latest survey, dated March 1998, health was the most important issue to older people and least important to people aged 35 44. In general, younger people were more concerned about long term environmental problems although 19 24 year olds, as well as 45 54 year olds were most concerned about unemployment. But the survey said 71% of Australians were concerned with at least one specific environmental problem. The figure was up from 68% in 1996 but down from 75% in 1992. People living in…
ACC331 201430 Assessment 3 February 2014 Page | 1 Question 1 15% of total assessment You have recently been appointed as an audit senior and have been assigned to the audit of TNO Limited (TNO) a listed public company. It is the beginning of January 2014 and you are gathering information in order to prepare the audit plan for the year ended 31 December 2013. The firm for which you work has been the auditor of TNO for a number of years. The following information has been gathered to date.
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Question 1 15% of total assessment You have recently been appointed as an audit senior and have been assigned to the audit of TNO Limited (TNO) a listed public company. It is the beginning of January 2014 and you are gathering information in order to prepare the audit plan for the year ended 31 December 2013. The firm for which you work has been the auditor of TNO for a number of years. The following information has been gathered to date. The principal activities of TNO are: ? research and development of technologies relating to medical equipment; ? manufacture and distribution of medical equipment; ? investment of surplus funds; and ? investment in the property market. TNO was incorporated in 1990 and has operated successfully and profitably since that date. In the last few years it has branched out into the property market, acquiring a number of commercial properties which are let mainly to medical practitioners. The directors of TNO are: ? Mr. John Stanton, Chairman ? Ms Jane Quade, Chief Executive Officer ? Mr. Joe Quade ? Dr Jim Xie ? Dr Jenny Yeo Doctors X and Y are independent non executive directors and have been directors since 2001. The other three executive directors have been employed by the company since its incorporation and have considerable experience in the industry. Mr Stanton controls a number of private companies. In prior years, the audit firm placed reliance on internal controls based on satisfactory results of extensive tests of control. Recent discussions with the client have revealed no changes in the system of internal control since last year. The company does not have an internal audit function. In February 2013, research activities relating to a new laser surgery device commenced. Significant costs were incurred in relation to this research. In April 2013 a competitor announced that it had successfully developed and patented a similar device. In order to finance the…
Instructions for the 2500 word assignment worth 20% due week 11,
The title is “How the concepts taught in a research methods course can help students deal with a wide variety problems and publish their findings”
Two examples of problems and solutions need to be discussed, these are
“How a university can reduce plagiarism” and “SUITABLE topic of your choice”
For the example “How a university can reduce plagiarism” you need to skim through the articles
Chao, C., Wilhelm, W. J., & Neureuther, B. D. (2009). A STUDY OF ELECTRONIC DETECTION AND PEDAGOGICAL APPROACHES FOR REDUCING PLAGIARISM. Delta Pi Epsilon Journal, 51(1), 31 42
This is available on EBSCO
Davis, M., & Carroll, J. (2009). Formative feedback within plagiarism education: Is there a role for text matching software?. International Journal for Educational Integrity, 5(2).
(This is available on google scholar)
Both of these article explain to how reduce plagiarism by discussing plagiarism reports
you will need to
*paraphrase the main findings of the articles
*discuss the research methods used
*discuss how the authors of the articles review the information found in OTHER sources
*discuss what ethics the RESEARCHERS needed to consider
*Compare and contrast the articles authority , validity and conclusions
For the example “SUITABLE topic of your choice” you need to find at least 5 references on a very specific aspect of the topic and paraphrase and carefully read at least two of the articles and discuss the research methods used,
for the 2 two articles you read carefully you will need to
*paraphrase the main findings of at least two of the articles
*discuss the research methods used
*discuss how the authors of the articles review the information found in OTHER sources
*discuss what ethics the RESEARCHERS needed to consider
*Compare and contrast the articles authority, validity and conclusion
*Find a “gap” in the articles and propose new research that would fill this gap, you do not have to do the research yourself
Please read the following scenario and answer the questions below. Please explain your reasoning.
Westerman Equipment Inc. manufactures and sells kitchen cooking products throughout the state. The company employs two salespersons. The following contribution margin by salesperson analysis was prepared:
Betty, whose tax rate is 33%, is in the business of breeding and racing horses. Except for the transactions below, she has no other sales or exchanges and she has no unrecaptured net Sec. 1231 losses. Consider the following transactions that occur during the year: • A building with an adjusted basis of $300,000 is destroyed by fire. Insurance proceeds of $500,000 are received, but Betty does not plan to replace the building. The building was built 12 years ago at a cost of $430,000 and used to provide lodging for her employees. Straight line depreciation has been used. • Four acres of the farm are condemned by the state to widen the highway and Betty receives $50,000. The land was inherited from her mother 15 years ago when its FMV was $15,000. Her mother purchased the land for $10,300. Betty does not plan to purchase additional land. • A racehorse purchased four years ago for $200,000 was sold for $550,000. Total depreciation allowed using the straight line method amounts to $160,000. • Equipment purchased three years ago for $200,000 is exchanged for $100,000 of IBM common stock. The adjusted basis of the equipment is $120,000. If straight line depreciation had been used, the adjusted basis would be $152,000. • An uninsured pony with an adjusted basis of $20,000 and FMV of $35,000, which her daughter uses only for personal use, is injured while attempting a jump. Because of the injury, the uninsured pony has to be destroyed by a veterinarian. Task(s): a. What amount of Sec. 1245 ordinary income must be recognized? 40,000 b. What amount of Sec. 1250 ordinary income must be recognized? 25, 000 c. Will the loss resulting from the destruction of her daughter’s pony be used to determine net Sec. 1231 gains or losses? Yes it can be determined d. What is the amount of the net Sec. 1231 gain or loss? Loss of 1600 e. After all of the netting of gains or losses is completed, will the gain resulting from the involuntary conversion of the building be treated as LTCG? f. What is the amount of her unrecaptured Sec. 1250 gain?
Your organization is a manufacturing company with employees in the following provinces:
British Columbia
Manitoba
Saskatchewan
Yukon
The organization is planning to implement a company wide policy with respect to bereavement leave that provides the same benefits to all employees, regardless of their province of employment and length of employment. Prepare a memo for the Human Resources Manager that responds to the following two points.
Identify for specific items related to bereavement leave that will have to be addressed in the policy to ensure compliance with the employment/standards in each jurisdiction.
Provide the recommendations toHuman Resources Manager on how to address each of the above items in the policy to provide the employee with the best benefit. Please explain your reasoning.
Dave Stevens, age 34, is a self employed physical therapist. His wife Sarah, age 31, teaches English as a Second Language at a local language school. Dave’s Social Securitynumber is 111 11 1111. Sarah’s Social Security number is 222 22 2222. Sarah and Dave have three children— Andrew, age 8; Isaac, age 6; and Mira, age 3. The children’s SocialSecurity numbers are, respectively, 333 33 3333, 444 44 4444, and 555 55 5555. They live at 12637 Pheasant Run, West Bend, Oregon 74658.
They paid $8,900 in qualified residence interest and $2,400 in property taxes on their home. They had cash charitable contributions of $14,000. They also paid $180 to a CPA for preparing their federal and state income tax returns for the prior year, $100 of which was for the preparation ofDave’s Schedule C.
Sarah and Dave earned interest on CDs of $3,200. Sarah’s salary forthe year is $32,000, from which $9,600 in federal income tax and $1,400 in state incometax were withheld. Dave’s office is located at Suite 402, 942 Woodview Drive, Portland, Oregon 74624, and his employer ID number is 11 1111111.
Dave has been practicing for four years, and he uses the cash method of accounting. During the current year, Dave recorded the following items of income:
Revenue from patient visits $300,000 Interest earned on the office checking balance 225
The following expenses were recorded on the office books:
Property taxes on the office Mortgage interest on the office Depreciation on the office Malpractice insurance
Utilities Office staff salaries Rent payments on equipment Office magazine subscriptions Office supplies Medical journals
Dave pays $50 annually for use of a safety deposit box to store certain confidential documents related to his business. In addition to his medical practice, Dave spends 15 hours every week managing his real estate investments. To make sure he is aware of all current investment strategies and best practices, he subscribes to the following journals:
Wall Street Journal $150
U.S. News & World Report 55
Money Magazine 45
Dave also paid $33,000 in estimated federal income taxes evenly during the year. These payments were made on the required due dates.
REQUIRED:
Prepare Dave and Sarah’sfederal income tax return (Form 1040, Schedules A, B, C, and SE) for the 2013 tax year. Disregard any tax credits for which they may be eligible. Do not prepare a state income tax return. Please complete this project without using tax software utilizing forms and worksheets available from the IRS web site. Show supporting calculations, including those found in worksheets to the instructions to Form 1040. If you make any assumptions, so state. This is an individual effort. Once you have completed the entire project, please scan into one pdf file
Part A Topic: CAPM “A Critical Assessment of The Capital Asset Pricing Model (CAPM)” You are required to
Describe the Capital Asset Pricing Model, including the assumptions underlying the theory
Explain the relationship between the Security Market Line and the Capital Market Line, using diagrams and examples to illustrate your explanation
Briefly set out arguments in favour of – and against the theory, outline its uses and make a critique of its underlying assumptions (Discussion and detailed understanding of CAPM, including its advantages and disadvantages and its role in in financial management. Source references used should be cited.)
Identify any alternatives which have been suggested in place of CAPM
Conclude with an overall assessment of the theory and state any recommendations which emerge for financial managers and investors, and summarise your overall conclusions. Your critique will be assessed.
You will need to discover at least 5 references FOR PART A
Use Harvard referencing! See Use Harvard referencing! See http://en.wikipedia.org/wiki/Harvard_referencing
Times New Roman font (at minimum , 12 pitch)
1.5 line spacing and A4 paper
Top, bottom, left and right margins to be at least 2.5 cms from the edge of the page;
PART B – Capital Budgeting Analysis
You are required to work the following problem, using a discounted cash flow (NPV) analysis. You should model your answer on the text approach in Chapter 8.
“Henry Hall is considering replacing an old machine with a new one. The old machine (purchased 5 years ago) cost $300,000, while the proposed new one will cost $250,000.
“The new machine will be depreciated prime cost to $50,000 over its 5 year life. Henry estimates that it will be worth $40,000 (salvage value) after 5 years.The old machine is being depreciated at prime cost to zero over its original expected life of 10 years. However, Henry can sell the old machine today for $78,000.
“The new machine will save the owner $50,000 a year in cooling costs. This was estimated one year ago in a feasibility study on the new machine conducted for Henry by an external firm of consultants, and which cost Henry $15,000. Henry still considers that these savings will be achieved.
“With the new machine, a one off amount of cleaning supplies at a cost of $5,000 will be required. and Henry estimates that accounts receivable will increase by $15,000. Both of these increases in working capital will be recouped at the end of the new machine’s life in five years time..
“Henry’s cost of capital is 10%. The tax rate is 30%. Tax is paid in the year in which earnings are received.
“REQUIRED.
Calculate the net present value of the proposed change, that is, the net benefit or net loss in present vaklue terms of the proposed changeover.
Should Henry purchase the new machine? State clearly why.”
The actual selling expenses incurred in March 2010 by Trusler Company are as follows.
Variable Expenses
Fixed Expenses
Sales commissions
$9,200
Sales salaries
$34,000
Advertising
7,000
Depreciation
7,000
Travel
5,100
Insurance
1,000
Delivery
3,500
Instructions
(a) Prepare a flexible budget performance report for March using the budget data in, assuming that March sales were $170,000. Expected and actual sales are the same.
(b) Prepare a flexible budget performance report, assuming that March sales were $180,000.
Expected sales and actual sales are the same.
(c) Comment on the importance of using flexible budgets in evaluating the performance of the sales manager.
Pletcher Company’s manufacturing overhead budget for the first quarter of 2010 contained the following data.
Variable Costs
Fixed Costs
Indirect materials
$12,000
Supervisory salaries
$36,000
Indirect labor
10,000
Depreciation
7,000
Utilities
8,000
Property taxes and insurance
8,000
Maintenance
6,000
Maintenance
5,000
Actual variable costs were: indirect materials $13,800, indirect labor $9,600, utilities $8,700, and maintenance $4,900. Actual fixed costs equaled budgeted costs except for property taxes and insurance, which were $8,200.
All costs are considered controllable by the production department manager except for depreciation, and property taxes and insurance.
Instructions
(a) Prepare a manufacturing overhead flexible budget report for the first quarter.
(b) Prepare a responsibility report for the first quarter.
As sales manager,Terry Dewitt was given the following static budget report for selling expenses in the Clothing Department of Garber Company for the month of October.
GARBER COMPANY Clothing Department Selling Expense Budget Report For the Month Ended October 31, 2010
Budget
Actual
Difference Favorable F Unfavorable U
Sales in units
8,000
10,000
2,000 F
Variable expenses
Sales commissions
$ 2,000
$ 2,600
$2,600 U
Advertising expense
800
850
50 U
Travel expense
3,600
4,000
400 U
Free samples given out
1,600
1,300
300 F
Total variable
8,000
8,750
750 U
Fixed expenses
Rent
1,500
1,500
–0–
Sales salaries
1,200
1,200
–0–
Office salaries
800
800
–0–
Depreciation—autos (sales staff)
500
500
–0–
Total fixed
4,000
4,000
–0–
Total expenses
$12,000
$12,750
$ 750 U
As a result of this budget report, Terry was called into the president’s office and congratulated on his fine sales performance. He was reprimanded, however, for allowing his costs to get out of control. Terry knew something was wrong with the performance report that he had been given. However, he was not sure what to do, and comes to you for advice.
Instructions
(a) Prepare a budget report based on flexible budget data to help Terry.
Pronto Plumbing Company is a newly formed company specializing in plumbing services for home and business. The owner, Paul Pronto, had divided the company into two segments: Home Plumbing Services and Business Plumbing Services. Each segment is run by its own supervisor, while basic selling and administrative services are shared by both segments.
Paul has asked you to help him create a performance reporting system that will allow him to measure each segment’s performance in terms of its profitability. To that end, the following information has been collected on the Home Plumbing Services segment for the first quarter of 2010.
Budgeted
Actual
Service revenue
$25,000
$26,000
Allocated portion of:
Building depreciation
11,000
11,000
Advertising
5,000
4,200
Billing
3,500
3,000
Property taxes
1,200
1,000
Material and supplies
1,500
1,200
Supervisory salaries
9,000
9,400
Insurance
4,000
3,500
Wages
3,000
3,300
Gas and oil
2,700
3,400
Equipment depreciation
1,600
1,300
Instructions
(a) Prepare a responsibility report for the first quarter of 2010 for the Home Plumbing Services segment.
(b) Write a memo to Paul Pronto discussing the principles that should be used when preparing performance reports.
Rensing Company has two production departments, Fabricating and Assembling. At a department managers’ meeting, the controller uses flexible budget graphs to explain total budgeted costs. Separate graphs based on direct labor hours are used for each department. The graphs show the following.
1. At zero direct labor hours, the total budgeted cost line and the fixed cost line intersect the vertical axis at $40,000 in the Fabricating Department and $30,000 in the Assembling Department.
2. At normal capacity of 50,000 direct labor hours, the line drawn from the total budgeted cost line intersects the vertical axis at $150,000 in the Fabricating Department, and $110,000 in the Assembling Department.
Instructions
(a) State the total budgeted cost formula for each department.
(b) Compute the total budgeted cost for each department, assuming actual direct labor hours worked were 53,000 and 47,000, in the Fabricating and Assembling Departments, respectively.
(c) Prepare the flexible budget graph for the Fabricating Department, assuming the maximum direct labor hours in the relevant range is 100,000. Use increments of 10,000 direct labor hours on the horizontal axis and increments of $50,000 on the vertical axis.
Lovell Company’s organization chart includes the president; the vice president of production; three assembly plants—Dallas, Atlanta, and Tucson; and two departments within each plant— Machining and Finishing. Budget and actual manufacturing cost data for July 2010 are as follows:
Finishing Department—Dallas: Direct materials $41,500 actual, $45,000 budget; direct labor $83,000 actual, $82,000 budget; manufacturing overhead $51,000 actual, $49,200 budget.
Machining Department—Dallas: Total manufacturing costs $220,000 actual, $216,000 budget.
Atlanta Plant: Total manufacturing costs $424,000 actual, $421,000 budget.
Tucson Plant: Total manufacturing costs $494,000 actual, $496,500 budget.
The Dallas plant manager’s office costs were $95,000 actual and $92,000 budget. The vice president of production’s office costs were $132,000 actual and $130,000 budget. Office costs are not allocated to departments and plants.
Instructions
Using the format on page 1076, prepare the reports in a responsibility system for:
The Mixing Department manager of Crede Company is able to control all overhead costs except rent, property taxes, and salaries. Budgeted monthly overhead costs for the Mixing Department, in alphabetical order, are:
Indirect labor
$12,000
Property taxes
$ 1,000
Indirect materials
7,500
Rent
1,800
Lubricants
1,700
Salaries
10,000
Maintenance
3,500
Utilities
5,000
Actual costs incurred for January 2010 are indirect labor $12,200; indirect materials $10,200; lubricants $1,650; maintenance $3,500; property taxes $1,100; rent $1,800; salaries $10,000; and utilities $6,500.
Instructions
(a) Prepare a responsibility report for January 2010.
(b) What would be the likely result of management’s analysis of the report?
Gonzales Manufacturing Inc. has three divisions which are operated as profit centers. Actual operating data for the divisions listed alphabetically are as follows.
Operating Data
Women’s Shoes
Men’s Shoes
Children’s Shoes
Contribution margin
$240,000
(3)
$180,000
Controllable fixed costs
100,000
(4)
(5)
Controllable margin
(1)
$ 90,000
96,000
Sales
600,000
450,000
(6)
Variable costs
(2)
330,000
250,000
Instructions
(a) Compute the missing amounts. Show computations.
(b) Prepare a responsibility report for the Women’s Shoe Division assuming (1) the data are for the month ended June 30, 2010, and (2) all data equal budget except variable costs which are $10,000 over budget.
The Sports Equipment Division of Brandon McCarthy Company is operated as a profit center. Sales for the division were budgeted for 2010 at $900,000. The only variable costs budgeted for the division were cost of goods sold ($440,000) and selling and administrative ($60,000). Fixed costs were budgeted at $100,000 for cost of goods sold, $90,000 for selling and administrative and $70,000 for non controllable fixed costs. Actual results for these items were:
Sales
$880,000
Cost of goods sold
Variable
409,000
Fixed
105,000
Selling and administrative
Variable
61,000
Fixed
67,000
Noncontrollable fixed
80,000
Instructions
(a) Prepare a responsibility report for the Sports Equipment Division for 2010.
(b) Assume, instead, the division is an investment center, and average operating assets were $1,000,000. Compute ROI.
The Green Division of Frizell Company reported the following data for the current year.
Sales
$3,000,000
Variable costs
1,950,000
Controllable fixed costs
600,000
Average operating assets
5,000,000
Top management is unhappy with the investment center’s return on investment (ROI). It asks the manager of the Green Division to submit plans to improve ROI in the next year. The manager believes it is feasible to consider the following independent courses of action.
1. Increase sales by $320,000 with no change in the contribution margin percentage.
2. Reduce variable costs by $100,000.
3. Reduce average operating assets by 4%.
Instructions
(a) Compute the return on investment (ROI) for the current year.
(b) Using the ROI formula, compute the ROI under each of the proposed courses of action. (Round to one decimal.)
The Medina and Ortiz Dental Clinic provides both preventive and orthodontic dental services. The two owners, Martin Medina and Olga Ortiz, operate the clinic as two separate investment centers: Preventive Services and Orthodontic Services. Each of them is in charge of one of the centers: Martin for Preventive Services and Olga for Orthodontic Services. Each month they prepare an income statement on the two centers to evaluate performance and make decisions about how to improve the operational efficiency and profitability of the clinic.
Recently they have been concerned about the profitability of the Preventive Services operations. For several months it has been reporting a loss. Shown below is the responsibility report for the month of May 2010.
Actual
Difference from Budget
Service revenue
$ 40,000
$1,000 F
Variable costs:
Filling materials
5,000
100 U
Novocain
4,000
200 U
Supplies
2,000
250 F
Dental assistant wages
2,500
–0–
Utilities
500
50 U
Total variable costs
14,000
100 U
Fixed costs:
Allocated portion of receptionist’s
salary
3,000
200 U
Dentist salary
10,000
500 U
Equipment depreciation
6,000
–0–
Allocated portion of building
depreciation
15,000
1,000 U
Total fixed costs
34,000
1,700 U
Operating income (loss)
$ (8,000)
$ 800 U
In addition, the owners know that the investment in operating assets at the beginning of the month was $82,400, and it was $77,600 at the end of the month. They have asked for your assistance in evaluating their current performance reporting system.
Instructions
(a) Prepare a responsibility report for an investment center as illustrated in the chapter.
(b) Write a memo to the owners discussing the deficiencies of their current reporting system.
The Transamerica Transportation Company uses a responsibility reporting system to measure the performance of its three investment centers: Planes, Taxis, and Limos. Segment performance is measured using a system of responsibility reports and return on investment calculations. The allocation of resources within the company and the segment managers’ bonuses are based in part on the results shown in these reports.
Recently, the company was the victim of a computer virus that deleted portions of the company’s accounting records. This was discovered when the current period’s responsibility reports were being prepared. The printout of the actual operating results appeared as follows.
Planes
Taxis
Limos
Service revenue
$ ?
$500,000
$ ?
Variable costs
5,500,000
?
320,000
Contribution margin
?
200,000
480,000
Controllable fixed costs
1,500,000
?
?
Controllable margin
?
80,000
240,000
Average operating assets
25,000,000
?
1,600,000
Return on investment
12%
10%
?
Instructions
Determine the missing pieces of information above.
Malone Company estimates that 360,000 direct labor hours will be worked during the coming year, 2010, in the Packaging Department. On this basis, the following budgeted manufacturing overhead cost data are computed for the year.
Fixed Overhead Costs
Variable Overhead Costs
Supervision
$ 90,000
Indirect labor
$126,000
Depreciation
60,000
Indirect materials
90,000
Insurance
30,000
Repairs
54,000
Rent
24,000
Utilities
72,000
Property taxes
18,000
Lubricants
18,000
$222,000
$360,000
It is estimated that direct labor hours worked each month will range from 27,000 to 36,000 hours. During October, 27,000 direct labor hours were worked and the following overhead costs were incurred.
(a) Prepare a monthly manufacturing overhead flexible budget for each increment of 3,000 direct labor hours over the relevant range for the year ending December 31, 2010.
(b) Prepare a flexible budget report for October.
(c) Comment on management’s efficiency in controlling manufacturing overhead costs in October.
Fultz Company manufactures tablecloths. Sales have grown rapidly over the past 2 years. As a result, the president has installed a budgetary control system for 2010.The following data were used in developing the master manufacturing overhead budget for the Ironing Department, which is based on an activity index of direct labor hours.
Variable Costs
Rate per Direct Labor Hour
Annual Fixed Costs
Indirect labor
$0.40
Supervision
$42,000
Indirect materials
0.50
Depreciation
18,000
Factory utilities
0.30
Insurance
12,000
Factory repairs
0.20
Rent
24,000
The master overhead budget was prepared on the expectation that 480,000 direct labor hours will be worked during the year. In June, 42,000 direct labor hours were worked. At that level of activity, actual costs were as shown below.
Variable—per direct labor hour: Indirect labor $0.43, Indirect materials $0.49, Factory utilities $0.32, and Factory repairs $0.24. Fixed: same as budgeted.
Instructions
(a) Prepare a monthly manufacturing overhead flexible budget for the year ending December 31, 2010, assuming production levels range from 35,000 to 50,000 direct labor hours. Use increments of 5,000 direct labor hours.
(b) Prepare a budget report for June comparing actual results with budget data based on the flexible budget.
(c) Were costs effectively controlled? Explain.
(d) State the formula for computing the total budgeted costs for Fultz Company.
(e) Prepare the flexible budget graph, showing total budgeted costs at 35,000 and 45,000 direct labor hours. Use increments of 5,000 direct labor hours on the horizontal axis and increments of $10,000 on the vertical axis.
Zelmer Company uses budgets in controlling costs. The August 2010 budget report for the company’s Assembling Department is as follows.
ZELMER COMPANY Budget Report Assembling Department For the Month Ended August 31, 2010
Manufacturing Costs
Budget
Actual
Difference Favorable F Unfavorable U
Variable costs
Direct materials
$ 48,000
$ 47,000
$1,000 F
Direct labor
54,000
51,300
2,700 F
Indirect materials
24,000
24,200
200 U
Indirect labor
18,000
17,500
500 F
Utilities
15,000
14,900
100 F
Maintenance
9,000
9,200
200 U
Total variable
168,000
164,100
3,900 F
Fixed costs
Rent
12,000
12,000
–0–
Supervision
17,000
17,000
–0–
Depreciation
7,000
7,000
–0–
Total fixed
36,000
36,000
–0–
Total costs
$204,000
$200,100
$3,900 F
The monthly budget amounts in the report were based on an expected production of 60,000 units per month or 720,000 units per year. The Assembling Department manager is pleased with the report and expects a raise, or at least praise for a job well done. The company president, however, is unhappy with the results for August, because only 58,000 units were produced.
Instructions
(a) State the total monthly budgeted cost formula.
(b) Prepare a budget report for August using flexible budget data. Why does this report provide a better basis for evaluating performance than the report based on static budget data?
(c) In September, 64,000 units were produced. Prepare the budget report using flexible budget data, assuming (1) each variable cost was 10% higher than its actual cost in August, and (2) fixed costs were the same in September as in August.
Dinkle Manufacturing Company manufactures a variety of tools and industrial equipment. The company operates through three divisions. Each division is an investment center. Operating data for the Home Division for the year ended December 31, 2010, and relevant budget data are as follows.
Actual
Comparison with Budget
Sales
$1,500,000
$100,000 favorable
Variable cost of goods sold
700,000
60,000 unfavorable
Variable selling and administrative expenses
125,000
25,000 unfavorable
Controllable fixed cost of goods sold
170,000
On target
Controllable fixed selling and administrative
expenses
80,000
On target
Average operating assets for the year for the Home Division were $2,500,000 which was also the budgeted amount.
Instructions
(a) Prepare a responsibility report (in thousands of dollars) for the Home Division.
(b) Evaluate the manager’s performance. Which items will likely be investigated by top management?
(c) Compute the expected ROI in 2011 for the Home Division, assuming the following independent changes to actual data.
(1) Variable cost of goods sold is decreased by 6%.
(2) Average operating assets are decreased by 10%.
(3) Sales are increased by $200,000, and this increase is expected to increase contribution margin by $90,000.
Nieto Company uses a responsibility reporting system. It has divisions in Denver, Seattle, and San Diego. Each division has three production departments: Cutting, Shaping, and Finishing. The responsibility for each department rests with a manager who reports to the division production manager. Each division manager reports to the vice president of production. There are also vice presidents for marketing and finance. All vice presidents report to the president.
In January 2010, controllable actual and budget manufacturing overhead cost data for the departments and divisions were as shown below.
Manufacturing Overhead
Actual
Budget
Individual costs—Cutting Department—Seattle
Indirect labor
$ 73,000
$ 70,000
Indirect materials
47,700
46,000
Maintenance
20,500
18,000
Utilities
20,100
17,000
Supervision
22,000
20,000
$183,300
$171,000
Total costs
Shaping Department—Seattle
$158,000
$148,000
Finishing Department—Seattle
210,000
206,000
Denver division
676,000
673,000
San Diego division
722,000
715,000
Additional overhead costs were incurred as follows: Seattle division production manager— actual costs $52,500, budget $51,000; vice president of production—actual costs $65,000, budget $64,000; president—actual costs $76,400, budget $74,200. These expenses are not allocated.
The vice presidents who report to the president, other than the vice president of production, had the following expenses.
Vice president
Actual
Budget
Marketing
$133,600
$130,000
Finance
109,000
105,000
Instructions
(a) Using the format on page 1076, prepare the following responsibility reports.
(1) Manufacturing overhead—Cutting Department manager—Seattle division.
Ogleby Company estimates that 240,000 direct labor hours will be worked during 2010 in the Assembly Department. On this basis, the following budgeted manufacturing overhead data are computed.
Variable Overhead Costs
Fixed Overhead Costs
Indirect labor
$ 72,000
Supervision
$ 75,000
Indirect materials
48,000
Depreciation
30,000
Repairs
36,000
Insurance
12,000
Utilities
26,400
Rent
9,000
Lubricants
9,600
Property taxes
6,000
$192,000
$132,000
It is estimated that direct labor hours worked each month will range from 18,000 to 24,000 hours. During January, 20,000 direct labor hours were worked and the following overhead costs were incurred.
Variable Overhead Costs
Fixed Overhead Costs
Indirect labor
$ 6,200
Supervision
$ 6,250
Indirect materials
3,600
Depreciation
2,500
Repairs
2,400
Insurance
1,000
Utilities
1,700
Rent
850
Lubricants
830
Property taxes
500
$14,730
$11,100
Instructions
(a) Prepare a monthly manufacturing overhead flexible budget for each increment of 2,000 direct labor hours over the relevant range for the year ending December 31, 2010.
(b) Prepare a manufacturing overhead budget report for January.
(c) Comment on management’s efficiency in controlling manufacturing overhead costs in January.
Parcells Manufacturing Company produces one product, Olpe. Because of wide fluctuations in demand for Olpe, the Assembly Department experiences significant variations in monthly production levels.
The annual master manufacturing overhead budget is based on 300,000 direct labor hours.
In July 27,500 labor hours were worked. The master manufacturing overhead budget for the year and the actual overhead costs incurred in July are as follows.
Overhead Costs
Master Budget (annual)
Actual in July
Variable
Indirect labor
$330,000
$29,000
Indirect materials
180,000
14,000
Utilities
90,000
8,100
Maintenance
60,000
5,400
Fixed
Supervision
150,000
12,500
Depreciation
96,000
8,000
Insurance and taxes
60,000
5,000
Total
$966,000
$82,000
Instructions
(a) Prepare a monthly overhead flexible budget for the year ending December 31, 2010, assuming monthly production levels range from 22,500 to 30,000 direct labor hours. Use increments of 2,500 direct labor hours.
(b) Prepare a budget report for the month of July 2010 comparing actual results with budget data based on the flexible budget.
(c) Were costs effectively controlled? Explain.
(d) State the formula for computing the total monthly budgeted costs in the Parcells Manufacturing Company.
(e) Prepare the flexible budget graph showing total budgeted costs at 25,000 and 27,500 direct labor hours. Use increments of 5,000 on the horizontal axis and increments of $10,000 on the vertical axis.
Fernetti Company uses budgets in controlling costs. The May 2010 budget report for the company’s Packaging Department is as follows.
FERNETTI COMPANY Budget Report Packaging Department For the Month Ended May 31, 2010
Manufacturing Costs
Budget
Actual
Difference Favorable F Unfavorable U
Variable costs
Direct materials
$ 40,000
$ 41,000
$1,000 U
Direct labor
45,000
47,000
2,000 U
Indirect materials
15,000
15,200
200 U
Indirect labor
12,500
13,000
500 U
Utilities
10,000
9,600
400 F
Maintenance
5,000
5,200
200 U
Total variable
127,500
131,000
3,500 U
Fixed costs
Rent
10,000
10,000
–0–
Supervision
7,000
7,000
–0–
Depreciation
5,000
5,000
–0–
Total fixed
22,000
22,000
–0–
Total costs
$149,500
$153,000
$3,500 U
The monthly budget amounts in the report were based on an expected production of 50,000 units per month or 600,000 units per year.
The company president was displeased with the department manager’s performance. The department manager, who thought he had done a good job, could not understand the unfavorable results. In May, 55,000 units were produced.
Instructions
(a) State the total budgeted cost formula.
(b) Prepare a budget report for May using flexible budget data. Why does this report provide a better basis for evaluating performance than the report based on static budget data?
(c) In June, 40,000 units were produced. Prepare the budget report using flexible budget data, assuming (1) each variable cost was 20% less in June than its actual cost in May, and (2) fixed costs were the same in the month of June as in May.
Colt Industries had sales in 2010 of $6,400,000 and gross profit of $1,100,000. Management is considering two alternative budget plans to increase its gross profit in 2011. Plan A would increase the selling price per unit from $8.00 to $8.40. Sales volume would decrease by 5% from its 2010 level. Plan B would decrease the selling price per unit by $0.50.The marketing department expects that the sales volume would increase by 150,000 units.
At the end of 2010, Colt has 40,000 units of inventory on hand. If Plan A is accepted, the 2011 ending inventory should be equal to 5% of the 2011 sales. If Plan B is accepted, the ending inventory should be equal to 50,000 units. Each unit produced will cost $1.80 in direct labor, $2.00 in direct materials, and $1.20 in variable overhead. The fixed overhead for 2011 should be $1,895,000.
Instructions
(a) Prepare a sales budget for 2011 under each plan.
(b) Prepare a production budget for 2011 under each plan.
(c) Compute the production cost per unit under each plan. Why is the cost per unit different for each of the two plans? (Round to two decimals.)
(d) Which plan should be accepted? (Hint: Compute the gross profit under each plan.)
Haas Company prepares monthly cash budgets. Relevant data from operating budgets for 2011 are:
January
February
Sales
$350,000
$400,000
Direct materials purchases
110,000
130,000
Direct labor
90,000
100,000
Manufacturing overhead
70,000
75,000
Selling and administrative expenses
79,000
86,000
All sales are on account. Collections are expected to be 50% in the month of sale, 30% in the first month following the sale, and 20% in the second month following the sale. Sixty percent (60%) of direct materials purchases are paid in cash in the month of purchase, and the balance due is paid in the month following the purchase. All other items above are paid in the month incurred except for selling and administrative expenses that include $1,000 of depreciation per month. Other data:
1. Credit sales: November 2010, $260,000; December 2010, $320,000.
2. Purchases of direct materials: December 2010, $100,000.
3. Other receipts: January—Collection of December 31, 2010, notes receivable $15,000; February—Proceeds from sale of securities $6,000.
4. Other disbursements: February—Withdrawal of $5,000 cash for personal use of owner, Dewey Yaeger. The company’s cash balance on January 1, 2011, is expected to be $60,000.The company wants to maintain a minimum cash balance of $50,000.
Instructions
(a) Prepare schedules for (1) expected collections from customers and (2) expected payments for direct materials purchases.
(b) Prepare a cash budget for January and February in columnar form.
The budget committee of Deleon Company collects the following data for its San Miguel Store in preparing budgeted income statements for May and June 2011.
1. Sales for May are expected to be $800,000. Sales in June and July are expected to be 10% higher than the preceding month.
2. Cost of goods sold is expected to be 75% of sales.
3. Company policy is to maintain ending merchandise inventory at 20% of the following month’s cost of goods sold.
4. Operating expenses are estimated to be:
Sales salaries
$30,000 per month
Advertising
5% of monthly sales
Delivery expense
3% of monthly sales
Sales commissions
4% of monthly sales
Rent expense
$5,000 per month
Depreciation
$800 per month
Utilities
$600 per month
Insurance
$500 per month
5. Income taxes are estimated to be 30% of income from operations.
Instructions
(a) Prepare the merchandise purchases budget for each month in columnar form.
(b) Prepare budgeted income statements for each month in columnar form. Show in the statements the details of cost of goods sold.
Glendo Industries’ balance sheet at December 31, 2010, is presented below and on the page.
GLENDO INDUSTRIES Balance Sheet December 31, 2010 Assets
Current assets
Cash
$ 7,500
Accounts receivable
82,500
Finished goods inventory (2,000 units)
30,000
Total current assets
120,000
Property, plant, and equipment
Equipment
$40,000
Less: Accumulated depreciation
10,000
30,000
Total assets
$150,000
Liabilities and Stockholders’ Equity
Liabilities
Notes payable
$ 25,000
Accounts payable
45,000
Total liabilities
70,000
Stockholders’ equity
Common stock
$50,000
Retained earnings
30,000
Total stockholders’ equity
80,000
Total liabilities and stockholders’ equity
$150,000
Additional information accumulated for the budgeting process is as follows.
Budgeted data for the year 2011 include the following.
4th Qtr. of 2011
Year 2011Total
Sales budget (8,000 units at $35)
$84,000
$280,000
Direct materials used
17,000
69,400
Direct labor
12,500
56,600
Manufacturing overhead applied
10,000
54,000
Selling and administrative expenses
18,000
76,000
To meet sales requirements and to have 3,000 units of finished goods on hand at December 31,
2011, the production budget shows 9,000 required units of output. The total unit cost of production is expected to be $20. Glendo Industries uses the first in, first out (FIFO) inventory costing method. Selling and administrative expenses include $4,000 for depreciation on equipment. Interest expense is expected to be $3,500 for the year. Income taxes are expected to be 30% of income before income taxes.
All sales and purchases are on account. It is expected that 60% of quarterly sales are collected in cash within the quarter and the remainder is collected in the following quarter.
Direct materials purchased from suppliers are paid 50% in the quarter incurred and the remainder in the following quarter. Purchases in the fourth quarter were the same as the materials used. In 2011, the company expects to purchase additional equipment costing $19,000. It expects to pay $8,000 on notes payable plus all interest due and payable to December 31 (included in interest expense $3,500, above). Accounts payable at December 31, 2011, includes amounts due suppliers (see above) plus other accounts payable of $5,700. In 2011, the company expects to declare and pay a $5,000 cash dividend. Unpaid income taxes at December 31 will be $5,000. The company’s cash budget shows an expected cash balance of $7,950 at December 31, 2011.
Instructions
Prepare a budgeted income statement for 2011 and a budgeted balance sheet at December 31, 2011. In preparing the income statement, you will need to compute cost of goods manufactured (direct materials + direct labor + manufacturing overhead) and finished goods inventory (December 31, 2011).
Suppan Farm Supply Company manufactures and sells a fertilizer called Basic II. The following data are available for preparing budgets for Basic II for the first 2 quarters of 2010.
1. Sales: Quarter 1, 40,000 bags; quarter 2, 50,000 bags. Selling price is $65 per bag.
2. Direct materials: Each bag of Basic II requires 6 pounds of Crup at a cost of $4 per pound and 10 pounds of Dert at $1.50 per pound.
3. Desired inventory levels:
Type of Inventory
January 1
April 1
July 1
Basic II (bags)
10,000
15,000
20,000
Crup (pounds)
9,000
12,000
15,000
Dert (pounds)
15,000
20,000
25,000
4. Direct labor: Direct labor time is 15 minutes per bag at an hourly rate of $10 per hour.
5. Selling and administrative expenses are expected to be 10% of sales plus $160,000 per quarter.
6. Income taxes are expected to be 30% of income from operations.
Your assistant has prepared two budgets: (1) The manufacturing overhead budget shows expected costs to be 100% of direct labor cost. (2) The direct materials budget for Dert which shows the cost of Dert to be $682,500 in quarter 1 and $825,00 in quarter 2.
Instructions
Prepare the budgeted income statement for the first 6 months of 2010 and all required supporting budgets by quarters. (Note: Use variable and fixed in the selling and administrative expense budget.) Do not prepare the manufacturing overhead budget or the direct materials budget for Dert.
Speier Industries has sales in 2010 of $5,600,000 (800,000 units) and gross profit of $1,344,000. Management is considering two alternative budget plans to increase its gross profit in 2011.
Plan A would increase the selling price per unit from $7.00 to $7.60. Sales volume would decrease by 10% from its 2010 level. Plan B would decrease the selling price per unit by 5%. The marketing department expects that the sales volume would increase by 100,000 units.
At the end of 2010, Speier has 70,000 units on hand. If Plan A is accepted, the 2011 ending inventory should be equal to 90,000 units. If Plan B is accepted, the ending inventory should be equal to 100,000 units. Each unit produced will cost $2.00 in direct materials, $1.50 in direct labor, and $0.50 in variable overhead. The fixed overhead for 2011 should be $925,000.
Instructions
(a) Prepare a sales budget for 2011 under (1) Plan A and (2) Plan B.
(b) Prepare a production budget for 2011 under (1) Plan A and (2) Plan B.
(c) Compute the cost per unit under (1) Plan A and (2) Plan B. Explain why the cost per unit is different for each of the two plans. (Round to two decimals.)
(d) Which plan should be accepted? (Hint: Compute the gross profit under each plan.)
The budget committee of Guzman Company collects the following data for its Westwood Store in preparing budgeted income statements for July and August 2010.
1. Expected sales: July $400,000,August $450,000, September $500,000.
2. Cost of goods sold is expected to be 60% of sales.
3. Company policy is to maintain ending merchandise inventory at 20% of the following month’s cost of goods sold.
4. Operating expenses are estimated to be:
Sales salaries
$50,000 per month
Advertising
4% of monthly sales
Delivery expense
2% of monthly sales
Sales commissions
3% of monthly sales
Rent expense
$3,000 per month
Depreciation
$700 per month
Utilities
$500 per month
Insurance
$300 per month
5. Income taxes are estimated to be 30% of income from operations.
Instructions
(a) Prepare the merchandise purchases budget for each month in columnar form.
(b) Prepare budgeted income statements for each month in columnar form. Show the details of cost of goods sold in the statements.
Lanier Corporation operates on a calendar year basis. It begins the annual budgeting process in late August when the president establishes targets for the total dollar sales and net income before taxes for the next year.
The sales target is given first to the marketing department. The marketing manager formulates a sales budget by product line in both units and dollars. From this budget, sales quotas by product line in units and dollars are established for each of the corporation’s sales districts.
The marketing manager also estimates the cost of the marketing activities required to support the target sales volume and prepares a tentative marketing expense budget.The executive vice president uses the sales and profit targets, the sales budget by product line, and the tentative marketing expense budget to determine the dollar amounts that can be devoted to manufacturing and corporate office expense.The executive vice president prepares the budget for corporate expenses. She then forwards to the production department the productline sales budget in units and the total dollar amount that can be devoted to manufacturing. The production manager meets with the factory managers to develop a manufacturing plan that will produce the required units when needed within the cost constraints set by the executive vice president. The budgeting process usually comes to a halt at this point because the production department does not consider the financial resources allocated to be adequate. When this standstill occurs, the vice president of finance, the executive vice president, the marketing manager, and the production manager meet together to determine the final budgets for each of the areas. This normally results in a modest increase in the total amount available for manufacturing costs and cuts in the marketing expense and corporate office expense budgets. The total sales and net income figures proposed by the president are seldom changed. Although the participants are seldom pleased with the compromise, these budgets are final. Each executive then develops a new detailed budget for the operations in his or her area.
None of the areas has achieved its budget in recent years. Sales often run below the target.
When budgeted sales are not achieved, each area is expected to cut costs so that the president’s profit target can be met. However, the profit target is seldom met because costs are not cut enough. In fact, costs often run above the original budget in all functional areas (marketing, production, and corporate office).
The president is disturbed that Lanier has not been able to meet the sales and profit targets.
He hired a consultant with considerable experience with companies in Lanier’s industry.
The consultant reviewed the budgets for the past 4 years. He concluded that the product line sales budgets were reasonable and that the cost and expense budgets were adequate for the budgeted sales and production levels.
Instructions
With the class divided into groups, answer the following.
(a) Discuss how the budgeting process employed by Lanier Corporation contributes to the failure to achieve the president’s sales and profit targets.
(b) Suggest how Lanier Corporation’s budgeting process could be revised to correct the problems.
(c) Should the functional areas be expected to cut their costs when sales volume falls below budget? Explain your answer.
Bedner & Flott Inc. manufactures ergonomic devices for computer users. Some of their more popular products include glare screens (for computer monitors), keyboard stands with wrist rests, and carousels that allow easy access to magnetic disks. Over the past 5 years, they experienced rapid growth, with sales of all products increasing 20% to 50% each year.
Last year, some of the primary manufacturers of computers began introducing new products with some of the ergonomic designs, such as glare screens and wrist rests, already built in. As a result, sales of Bedner & Flott’s accessory devices have declined somewhat. The company believes that the disk carousels will probably continue to show growth, but that the other products will probably continue to decline. When the next year’s budget was prepared, increases were built in to research and development so that replacement products could be developed or the company could expand into some other product line. Some product lines being considered are general purpose ergonomic devices including back supports, foot rests, and sloped writing pads.
The most recent results have shown that sales decreased more than was expected for the glare screens. As a result, the company may have a shortage of funds. Top management has therefore asked that all expenses be reduced 10% to compensate for these reduced sales. Summary budget information is as follows.
Direct materials
$240,000
Direct labor
110,000
Insurance
50,000
Depreciation
90,000
Machine repairs
30,000
Sales salaries
50,000
Office salaries
80,000
Factory salaries (indirect labor)
50,000
Total
$700,000
Instructions
Using the information above, answer the following questions.
(a) What are the implications of reducing each of the costs? For example, if the company reduces direct materials costs, it may have to do so by purchasing lower quality materials. This may affect sales in the long run.
(b) Based on your analysis in (a), what do you think is the best way to obtain the $70,000 in cost savings requested? Be specific. Are there any costs that cannot or should not be reduced? Why?
In order to better serve their rural patients, Drs. Dan and Jack Fleming (brothers) began giving safety seminars. Especially popular were their “emergency preparedness” talks given to farmers. Many people asked whether the “kit” of materials the doctors recommended for common farm emergencies was commercially available.
After checking with several suppliers, the doctors realized that no other company offered the supplies they recommended in their seminars, packaged in the way they described. Their wives, Julie and Amy, agreed to make a test package by ordering supplies from various medical supply companies and assembling them into a “kit” that could be sold at the seminars. When these kits proved a runaway success, the sisters in law decided to market them. At the advice of their accountant, they organized this venture as a separate company, called Life Protection Products (LPP), with Julie Fleming as CEO and Amy Fleming as Secretary Treasurer. LPP soon started receiving requests for the kits from all over the country, as word spread about their availability. Even without advertising, LPP was able to sell its full inventory every month. However, the company was becoming financially strained. Julie and Amy had about $100,000 in savings, and they invested about half that amount initially. They believed that this venture would allow them to make money. However, at the present time, only about $30,000 of the cash remains, and the company is constantly short of cash. Julie has come to you for advice. She does not understand why the company is having cash flow problems. She and Amy have not even been withdrawing salaries. However, they have rented a local building and have hired two more full time workers to help them cope with the increasing demand. They do not think they could handle the demand without this additional help. Julie is also worried that the cash problems mean that the company may not be able to support itself. She has prepared the cash budget shown below. All seminar customers pay for their products in full at the time of purchase. In addition, several large companies have ordered the kits for use by employees who work in remote sites. They have requested credit terms and have been allowed to pay in the month following the sale. These large purchasers amount to about 25% of the sales at the present time. LPP purchases the materials for the kits about 2 months ahead of time. Julie and Amy are considering slowing the growth of the company by simply purchasing less materials, which will mean selling fewer kits. The workers are paid in cash weekly. Julie and Amy need about $15,000 cash on hand at the beginning of the month to pay for purchases of raw materials. Right now they have been using cash from their savings, but as noted, only $30,000 is left.
Instructions
Write a response to Julie Fleming. Explain why LPP is short of cash. Will this company be able to support itself? Explain your answer. Make any recommendations you deem appropriate.
LIFE PROTECTION PRODUCTS Cash Budget For the Quarter Ending June 30, 2011
You are an accountant in the budgetary, projections, and special projects department of American Conductor, Inc., a large manufacturing company. The president, William Brown, asks you on very short notice to prepare some sales and income projections covering the next 2 years of the company’s much heralded new product lines. He wants these projections for a series of speeches he is making while on a 2 week trip to eight East Coast brokerage firms. The president hopes to bolster American’s stock sales and price.
You work 23 hours in 2 days to compile the projections, hand deliver them to the president, and are swiftly but graciously thanked as he departs. A week later you find time to go over some of your computations and discover a miscalculation that makes the projections grossly overstated. You quickly inquire about the president’s itinerary and learn that he has made half of his speeches and has half yet to make. You are in a quandary as to what to do.
Instructions
(a) What are the consequences of telling the president of your gross miscalculations?
(b) What are the consequences of not telling the president of your gross miscalculations?
(c) What are the ethical considerations to you and the president in this situation?
The All About You feature in this chapter emphasizes that in order to get your personal finances under control, you need to prepare a personal budget. Assume that you have compiled the following information regarding your expected cash flows for a typical month.
Rent payment
$ 400
Miscellaneous costs
$110
Interest income
50
Savings
50
Income tax withheld
300
Eating out
150
Electricity bill
22
Telephone and Internet costs
90
Groceries
80
Student loan payments
275
Wages earned
2,000
Entertainment costs
250
Insurance
100
Transportation costs
150
Instructions
Using the information above, prepare a personal budget. In preparing this budget, use the format found at. Just skip any unused line items.
The service division of Retro Industries reported the following results for 2010.
Sales
$500,000
Variable costs
300,000
Controllable fixed costs
75,000
Average operating assets
450,000
Management is considering the following independent courses of action in 2011 in order to maximize the return on investment for this division.
1. Reduce average operating assets by $50,000, with no change in controllable margin.
2. Increase sales $100,000, with no change in the contribution margin percentage.
(a) Compute the controllable margin and the return on investment for 2010. (b) Compute the controllable margin and the expected return on investment for each proposed alternative.
Jim Thome has prepared the following list of statements about budgetary control.
1. Budget reports compare actual results with planned objectives.
2. All budget reports are prepared on a weekly basis.
3. Management uses budget reports to analyze differences between actual and planned results and determine their causes.
4. As a result of analyzing budget reports, management may either take corrective action or modify future plans.
5. Budgetary control works best when a company has an informal reporting system.
6. The primary recipients of the sales report are the sales manager and the vice president of production.
7. The primary recipient of the scrap report is the production manager.
8. A static budget is a projection of budget data at one level of activity.
9. Top management’s reaction to unfavorable differences is not influenced by the materiality of the difference.
10. A static budget is not appropriate in evaluating a manager’s effectiveness in controlling costs unless the actual activity level approximates the static budget activity level or the behavior of the costs is fixed.
Instructions
Identify each statement as true or false. If false, indicate how to correct the statement.
Raney Company uses a flexible budget for manufacturing overhead based on direct labor hours. Variable manufacturing overhead costs per direct labor hour are as follows.
Indirect labor
$1.00
Indirect materials
0.50
Utilities
0.40
Fixed overhead costs per month are: Supervision $4,000, Depreciation $1,500, and Property Taxes $800.The company believes it will normally operate in a range of 7,000–10,000 direct labor hours per month.
Instructions
Prepare a monthly manufacturing overhead flexible budget for 2010 for the expected range of activity, using increments of 1,000 direct labor hours.
Keppel Manufacturing had a bad year in 2010. For the first time in its history it operated at a loss. The company’s income statement showed the following results from selling 60,000 units of product: Net sales $1,500,000; total costs and expenses $1,890,000; and net loss $390,000. Costs and expenses consisted of the amounts shown on the page.
Total
Variable
Fixed
Cost of goods sold
$1,350,000
$930,000
$420,000
Selling expenses
420,000
65,000
355,000
Administrative expenses
120,000
55,000
65,000
$1,890,000
$1,050,000
$840,000
Management is considering the following independent alternatives for 2011.
1. Increase unit selling price 40% with no change in costs, expenses, and sales volume.
2. Change the compensation of salespersons from fixed annual salaries totaling $200,000 to total
salaries of $30,000 plus a 4% commission on net sales.
3. Purchase new high tech factory machinery that will change the proportion between variable and fixed cost of goods sold to 50:50.
Instructions
(a) Compute the break even point in dollars for 2010.
(b) Compute the break even point in dollars under each of the alternative courses of action. Which course of action do you recommend?
Jane Greinke is the advertising manager for Payless Shoe Store. She is currently working on a major promotional campaign. Her ideas include the installation of a new lighting system and increased display space that will add $24,000 in fixed costs to the $210,000 currently spent. In addition, Jane is proposing that a 62/3% price decrease (from $30 to $28) will produce an increase in sales volume from 16,000 to 20,000 units.Variable costs will remain at $15 per pair of shoes.
Management is impressed with Jane’s ideas but concerned about the effects that these changes will have on the break even point and the margin of safety.
Instructions
(a) Compute the current break even point in units, and compare it to the break even point in units if Jane’s ideas are used.
(b) Compute the margin of safety ratio for current operations and after Jane’s changes are introduced. (Round to nearest full percent.)
(c) Prepare a CVP income statement for current operations and after Jane’s changes are introduced. Would you make the changes suggested?
Mortonsen Corporation has collected the following information after its first year of sales. Net sales were $2,000,000 on 100,000 units; selling expenses $400,000 (30% variable and 70% fixed); direct materials $600,000; direct labor $340,000; administrative expenses $500,000 (30% variable and 70% fixed); manufacturing overhead $480,000 (20% variable and 80% fixed).
Top management has asked you to do a CVP analysis so that it can make plans for the coming year. It has projected that unit sales will increase by 20% next year.
Instructions
(a) Compute (1) the contribution margin for the current year and the projected year, and (2) the fixed costs for the current year. (Assume that fixed costs will remain the same in the projected year.)
(b) Compute the break even point in units and sales dollars.
(c) The company has a target net income of $374,000.What is the required sales in dollars for the company to meet its target?
(d) If the company meets its target net income number, by what percentage could its sales fall before it is operating at a loss? That is, what is its margin of safety ratio?
(e) The company is considering a purchase of equipment that would reduce its direct labor costs by $140,000 and would change its manufacturing overhead costs to 10% variable and 90% fixed (assume total manufacturing overhead cost is $480,000, as above). It is also considering switching to a pure commission basis for its sales staff. This would change selling expenses to 80% variable and 20% fixed (assume total selling expense is $400,000, as above). Compute (1) the contribution margin and (2) the contribution margin ratio, and recompute (3) the break even point in sales dollars. Comment on the effect each of management’s proposed changes has on the break even point.
Blanco Metal Company produces the steel wire that goes into the production of paper clips. In 2010, the first year of operations, Blanco produced 50,000 miles of wire and sold 45,000 miles.
In 2011, the production and sales results were exactly reversed. In each year, selling price permile was $60, variable manufacturing costs were 20% of the sales price, variable selling expenses were $8.00 per mile sold, fixed manufacturing costs were $1,200,000, and fixed administrative expenses were $230,000.
Instructions
(a) Prepare comparative income statements for each year using variable costing.
(b) Prepare comparative income statements for each year using absorption costing.
(c) Reconcile the differences each year in income from operations under the two costing approaches.
(d) Comment on the effects of production and sales on net income under the two costing approaches.
Gagliano Company has decided to introduce a new product. The new product can be manufactured by either a capital intensive method or a labor intensive method. The manufacturing method will not affect the quality of the product. The estimated manufacturing costs by the two methods are as follows.
Capital
Labor
Intensive
Intensive
Direct materials
$5 per unit
$5.50 per unit
Direct labor
$6 per unit
$8.00 per unit
Variable overhead
$3 per unit
$4.50 per unit
Fixed manufacturing costs
$2,508,000
$1,538,000
Gagliano’s market research department has recommended an introductory unit sales price of $30. The incremental selling expenses are estimated to be $502,000 annually plus $2 for each unit sold, regardless of manufacturing method.
Instructions
With the class divided into groups, answer the following.
(a) Calculate the estimated break even point in annual unit sales of the new product if Gagliano
Company uses the:
(1) capital intensive manufacturing method.
(2) labor intensive manufacturing method.
(b) Determine the annual unit sales volume at which Gagliano Company would be indifferent between the two manufacturing methods.
(c) Explain the circumstance under which Gagliano should employ each of the two manufacturing methods.
The condensed income statement for the Terri and Jerri partnership for 2010 is as follows.
TERRI AND JERRI COMPANY Income Statement For the Year Ended December 31, 2010
Sales (200,000 units)
$1,200,000
Cost of goods sold
800,000
Gross profit
400,000
Operating expenses
Selling
$280,000
Administrative
160,000
440,000
Net loss
($40,000)
A cost behavior analysis indicates that 75% of the cost of goods sold are variable, 50% of the selling expenses are variable, and 25% of the administrative expenses are variable.
Instructions
(Round to nearest unit, dollar, and percentage, where necessary. Use the CVP income statement format in computing profits.)
(a) Compute the break even point in total sales dollars and in units for 2010.
(b) Terri has proposed a plan to get the partnership “out of the red” and improve its profitability.
She feels that the quality of the product could be substantially improved by spending $0.25 more per unit on better raw materials. The selling price per unit could be increased to only $6.25 because of competitive pressures. Terri estimates that sales volume will increase by 30%.
What effect would Terri’s plan have on the profits and the break even point in dollars of the partnership? (Round the contribution margin ratio to two decimal places.)
(c) Jerri was a marketing major in college. She believes that sales volume can be increased only by intensive advertising and promotional campaigns. She therefore proposed the following plan as an alternative to Terri’s. (1) Increase variable selling expenses to $0.79 per unit, (2) lower the selling price per unit by $0.30, and (3) increase fixed selling expenses by $35,000. Jerri quoted an old marketing research report that said that sales volume would increase by 60% if these changes were made. What effect would Jerri’s plan have on the profits and the break even point in dollars of the partnership?
(d) Which plan should be accepted? Explain your answer.
Kenny Hampton is an accountant for Bartley Company. Early this year Kenny made a highly favorable projection of sales and profits over the next 3 years for Bartley’s hot selling computer PLEX. As a result of the projections Kenny presented to senior management, they decided to expand production in this area. This decision led to dislocations of some plant personnel who were reassigned to one of the company’s newer plants in another state. However, no one was fired, and in fact the company expanded its work force slightly.
Unfortunately Kenny rechecked his computations on the projections a few months later and found that he had made an error that would have reduced his projections substantially.
Luckily, sales of PLEX have exceeded projections so far, and management is satisfied with its decision. Kenny, however, is not sure what to do. Should he confess his honest mistake and jeopardize his possible promotion? He suspects that no one will catch the error because sales of PLEX have exceeded his projections, and it appears that profits will materialize close to his projections.
Instructions
(a) Who are the stakeholders in this situation?
(b) Identify the ethical issues involved in this situation.
(c) What are the possible alternative actions for Kenny? What would you do in Kenny’s position?
In the All About You feature in this chapter, you learned that cost volumeprofit analysis can be used in making personal financial decisions. The purchase of a new car is one of your biggest personal expenditures. It is important that you carefully analyze your options.
Suppose that you are considering the purchase of a hybrid vehicle. Let’s assume the following facts: The hybrid will initially cost an additional $3,000 above the cost of a traditional vehicle. The hybrid will get 40 miles per gallon of gas, and the traditional car will get 25 miles per gallon. Also, assume that the cost of gas is $4 per gallon.
Instructions
Using the facts above, answer the following questions.
(a) What is the variable gasoline cost of going one mile in the hybrid car? What is the variable cost of going one mile in the traditional car?
(b) Using the information in part (a), if “miles” is your unit of measure, what is the “contribution margin” of the hybrid vehicle relative to the traditional vehicle? That is, express the variable cost savings on a per mile basis.
(c) How many miles would you have to drive in order to break even on your investment in the hybrid car?
(d) What other factors might you want to consider?
Use this list of terms to complete the sentences that follow.
Long range planning
Participative budgeting
Sales forecast
Operating budgets
Master budget
Financial budgets
1. A ________________ shows potential sales for the industry and a company’s expected share of such sales.
2. __________________ are used as the basis for the preparation of the budgeted income statement.
3. The _______________ is a set of interrelated budgets that constitutes a plan of action for a specified time period.
4. ___________________ identifies long term goals, selects strategies to achieve these goals, and develops policies and plans to implement the strategies.
5. Lower level managers are more likely to perceive results as fair and achievable under a ________________ approach.
6. ___________________ focus primarily on the cash resources needed to fund expected operations and planned capital expenditures.
Barrett Company has completed all operating budgets other than the income statement for 2010. Selected data from these budgets follow.
Sales: $300,000
Purchases of raw materials: $145,000
Ending inventory of raw materials: $15,000
Direct labor: $40,000
Manufacturing overhead: $73,000, including $3,000 of depreciation expense
Selling and administrative expenses: $36,000 including depreciation expense of $1,000
Interest expense: $1,000
Principal payment on note: $2,000
Dividends declared: $2,000
Income tax rate: 30%
Other information:
Year end accounts receivable: 4% of 2010 sales
Year end accounts payable: 50% of ending inventory of raw materials Interest, direct labor, manufacturing overhead, and selling and administrative expenses other than depreciation are paid as incurred. Dividends declared and income taxes for 2010 will not be paid until 2011.
BARRETT COMPANY Balance Sheet December 31, 2009
Cash
Assets
$20,000
Raw materials inventory
10,000
Equipment
$40,000
Less: Accumulated depreciation
4,000
36,000
Total assets
$66,000
Liabilities and Stockholders’ Equity
Accounts payable
$ 5,000
Notes payable
22,000
Total liabilities
$27,000
Common stock
25,000
Retained earnings
14,000
39,000
Total liabilities and stockholders’ equity
$66,000
Instructions
(a) Calculate budgeted cost of goods sold.
(b) Prepare a budgeted income statement for the year ending December 31, 2010.
(c) Prepare a budgeted balance sheet as of December 31, 2010.
Oak Creek Company is preparing its master budget for 2010. Relevant data pertaining to its sales, production, and direct materials budgets are as follows.
Sales: Sales for the year are expected to total 1,000,000 units. Quarterly sales are 20%, 25%, 25%, and 30% respectively.The sales price is expected to be $40 per unit for the first three quarters and $45 per unit beginning in the fourth quarter. Sales in the first quarter of 2011 are expected to be 10% higher than the budgeted sales for the first quarter of 2010. Production: Management desires to maintain the ending finished goods inventories at 20% of the next quarter’s budgeted sales volume.
Direct materials: Each unit requires 2 pounds of raw materials at a cost of $10 per pound. Management desires to maintain raw materials inventories at 10% of the next quarter’s production requirements. Assume the production requirements for first quarter of 2011 are 500,000 pounds.
Prepare the sales, production, and direct materials budgets by quarters for 2010.
Zeller Electronics Inc. produces and sells two models of pocket calculators, XQ 103 and XQ 104. The calculators sell for $12 and $25, respectively. Because of the intense competition Zeller faces, management budgets sales semiannually. Its projections for the first 2 quarters of 2010 are as follows.
Unit Sales
Product
Quarter 1
Quarter 2
XQ 103
20,000
25,000
XQ 104
12,000
15,000
No changes in selling prices are anticipated.
Instructions
Prepare a sales budget for the 2 quarters ending June 30, 2010. List the products and show for each quarter and for the 6 months, units, selling price, and total sales by product and in total.
Turney Company produces and sells automobile batteries, the heavy duty HD 240.The 2010 sales budget is as follows.
Quarter
HD 240
1
5,000
2
7,000
3
8,000
4
10,000
The January 1, 2010, inventory of HD 240 is 2,500 units. Management desires an ending inventory each quarter equal to 50% of the next quarter’s sales. Sales in the first quarter of 2011 are expected to be 30% higher than sales in the same quarter in 2010.
Instructions
Prepare quarterly production budgets for each quarter and in total for 2010.
Moreno Industries has adopted the following production budget for the first 4 months of 2011.
Month
Units
Month
Units
January
10,000
March
5,000
February
8,000
April
4,000
Each unit requires 3 pounds of raw materials costing $2 per pound. On December 31, 2010, the ending raw materials inventory was 9,000 pounds. Management wants to have a raw materials inventory at the end of the month equal to 30% of next month’s production requirements.
Instructions
Prepare a direct materials purchases budget by month for the first quarter.
On January 1, 2011 the Batista Company budget committee has reached agreement on the following data for the 6 months ending June 30, 2011.
Sales units:
First quarter 5,000; second quarter 6,000; third quarter 7,000
Ending raw materials inventory:
50% of the next quarter’s production requirements
Ending finished goods inventory:
30% of the next quarter’s expected sales units
Third quarter production:
7,250 units
The ending raw materials and finished goods inventories at December 31, 2010, follow the same percentage relationships to production and sales that occur in 2011.Three pounds of raw materials are required to make each unit of finished goods. Raw materials purchased are expected to cost $4 per pound.
Instructions
(a) Prepare a production budget by quarters for the 6 month period ended June 30, 2011.
(b) Prepare a direct materials budget by quarters for the 6 month period ended June 30, 2011.
NIU Company’s budgeted sales and direct materials purchases are as follows.
Budgeted Sales
Budgeted D.M. Purchases
January
$200,000
$30,000
February
220,000
35,000
March
270,000
41,000
NIU’s sales are 40% cash and 60% credit. Credit sales are collected 10% in the month of sale, 50% in the month following sale, and 36% in the second month following sale; 4% are uncollectible.
NIU’s purchases are 50% cash and 50% on account. Purchases on account are paid 40% in the month of purchase, and 60% in the month following purchase.
Instructions
(a) Prepare a schedule of expected collections from customers for March.
(b) Prepare a schedule of expected payments for direct materials for March.
Environmental Landscaping Inc. is preparing its budget for the first quarter of 2010.
The next step in the budgeting process is to prepare a cash receipts schedule and a cash payments schedule. To that end the following information has been collected.
Clients usually pay 60% of their fee in the month that service is provided, 30% the month after, and 10% the second month after receiving service.
Actual service revenue for 2009 and expected service revenues for 2010 are: November 2009, $90,000; December 2009, $80,000; January 2010, $100,000; February 2010, $120,000; March 2010, $130,000.
Purchases on landscaping supplies (direct materials) are paid 40% in the month of purchase and 60% the following month. Actual purchases for 2009 and expected purchases for 2010 are: December 2009, $14,000; January 2010, $12,000; February 2010, $15,000; March 2010, $18,000.
Instructions
(a) Prepare the following schedules for each month in the first quarter of 2010 and for the quarter in total:
(1) Expected collections from clients.
(2) Expected payments for landscaping supplies.
(b) Determine the following balances at March 31, 2010:
Donnegal Dental Clinic is a medium sized dental service specializing in family dental care. The clinic is currently preparing the master budget for the first 2 quarters of 2010. All that remains in this process is the cash budget. The following information has been collected from other portions of the master budget and elsewhere.
Beginning cash balance
$ 30,000
Required minimum cash balance
25,000
Payment of income taxes (2nd quarter)
4,000
Professional salaries:
1st quarter
140,000
2nd quarter
140,000
Interest from investments (2nd quarter)
5,000
Overhead costs:
1st quarter
75,000
2nd quarter
100,000
Selling and administrative costs, including
$3,000 depreciation:
1st quarter
50,000
2nd quarter
70,000
Purchase of equipment (2nd quarter)
50,000
Sale of equipment (1st quarter)
15,000
Collections from clients:
1st quarter
230,000
2nd quarter
380,000
Interest payments (2nd quarter)
300
Instructions
Prepare a cash budget for each of the first two quarters of 2010.
Danner Farm Supply Company manufactures and sells a pesticide called Snare. The following data are available for preparing budgets for Snare for the first 2 quarters of 2011.
1. Sales: Quarter 1, 28,000 bags; quarter 2, 42,000 bags. Selling price is $60 per bag.
2. Direct materials: Each bag of Snare requires 4 pounds of Gumm at a cost of $4 per pound and 6 pounds of Tarr at $1.50 per pound.
3. Desired inventory levels:
Type of Inventory
January 1
April 1
July 1
Snare (bags)
8,000
12,000
18,000
Gumm (pounds)
9,000
10,000
13,000
Tarr (pounds)
14,000
20,000
25,000
4. Direct labor: Direct labor time is 15 minutes per bag at an hourly rate of $14 per hour.
5. Selling and administrative expenses are expected to be 15% of sales plus $175,000 per quarter.
6. Income taxes are expected to be 30% of income from operations.
Your assistant has prepared two budgets: (1) The manufacturing overhead budget shows expected costs to be 150% of direct labor cost. (2) The direct materials budget for Tarr shows the cost of Tarr purchases to be $297,000 in quarter 1 and $421,500 in quarter 2.
Instructions
Prepare the budgeted income statement for the first 6 months and all required supporting budgets by quarters. (Note: Use variable and fixed in the selling and administrative expense budget). Do not prepare the manufacturing overhead budget or the direct materials budget for Tarr.
Larussa Inc. is preparing its annual budgets for the year ending December 31, 2011. Accounting assistants furnish the data shown below.
Product JB 50
Product JB 60
Sales budget:
Anticipated volume in units
400,000
200,000
Unit selling price
$20
$25
Production budget:
Desired ending finished goods units
25,000
15,000
Beginning finished goods units
30,000
10,000
Direct materials budget:
Direct materials per unit (pounds)
2
3
Desired ending direct materials pounds
30,000
15,000
Beginning direct materials pounds
40,000
10,000
Cost per pound
$3
$4
Direct labor budget:
Direct labor time per unit
0.4
0.6
Direct labor rate per hour
$12
$12
Budgeted income statement:
Total unit cost
$12
$21
An accounting assistant has prepared the detailed manufacturing overhead budget and the selling and administrative expense budget. The latter shows selling expenses of $660,000 for product JB 50 and $360,000 for product JB 60, and administrative expenses of $540,000 for product JB 50 and $340,000 for product JB 60. Income taxes are expected to be 30%.
Instructions
Prepare the following budgets for the year. Show data for each product. You do not need to prepare quarterly budgets.
(a) Sales
(b) Production
(c) Direct materials
(d) Direct labor
(e) Income statement (Note: Income taxes are not allocated to the products.)
Gardner Corporation holds 80 percent of Healthstone, which, in turn, owns 80 percent of Icede. Operational income figures (without investment income) as well as unrealized upstream gains included in the income for the current year follow:
Gardner
Healthstone
Icede
Operational income
$400,000
$300,000
$220,000
Unrealized gains
50,000
30,000
60,000
What balance does the consolidated income statement for the year report for the noncontrolling interest in the subsidiaries’ income?
On January 1, 2009, Tree Company acquired 70 percent of Limb Company’s outstanding voting stock for $252,000. Limb reported a $300,000 book value and the fair value of the noncontrolling interest was $108,000 on that date. Subsequently, on January 1, 2010, Limb acquired 70 percent of Leaf Company for $91,000 when Leaf had a $100,000 book value and the 30 percent noncontrolling interest was valued at $39,000. In each acquisition, any excess acquisition date fair value over book value was assigned to a trade name with a 30 year life.
These companies report the following financial information. Investment income figures are not included.
2009
2010
2011
Sales:
Tree Company
$400,000
$500,000
$650,000
Limb Company
200,000
280,000
400,000
Leaf Company
Not available
160,000
210,000
Expenses:
Tree Company
$310,000
$420,000
$510,000
Limb Company
160,000
220,000
335,000
Leaf Company
Not available
150,000
180,000
Dividends
Tree Company
$20,000
$40,000
$50,000
Limb Company
10,000
20,000
20,000
Leaf Company
Not available
2,000
10,000
Assume that each of the following questions is independent:
a. If all companies use the equity method for internal reporting purposes, what is the December 31, 2010, balance in Tree’s Investment in Limb Company account?
b. If all companies use the initial value method to account for their investments, what adjustments must Limb and Tree make to their beginning Retained Earnings balances on the 2011 consolidation worksheet?
c. What is the consolidated net income for this business combination for the year of 2011 prior to any reduction for the noncontrolling interests’ share of the subsidiaries’ net income?
d. What is the noncontrolling interests’ share of the consolidated net income in 2011?
e. Assume that Limb made intra entity inventory transfers to Tree that have resulted in the following unrealized gains at the end of each year:
Date
Amount
12/31/2009
$10,000
12/31/2010
16,000
12/31/2011
25,000
What is the realized income of Limb in 2010 and 2011, respectively?
f. In assuming the same unrealized profits as presented in part (e), what worksheet adjustment must be made to Tree’s January 1, 2011, Retained Earnings account if that company has applied the initial value method to its investment?
On January 1, 2009, Uncle Company purchased 80 percent of Nephew Company’s capital stock for $500,000 in cash and other assets. Nephew had a book value of $600,000 and the 20 percent noncontrolling interest fair value was $125,000 on that date. On January 1, 2008, Nephew had acquired 30 percent of Uncle for $280,000. Uncle’s appropriately adjusted book value as of that date was $900,000.
Operational income figures (including no investment income) for these two companies follow. In addition, Uncle pays $20,000 in dividends to shareholders each year and Nephew distributes $5,000 annually. Any excess fair value allocations are amortized over a 10 year period.
Year
Uncle Company
Nephew Company
2009
$90,000
$30,000
2010
120,000
40,000
2011
140,000
50,000
a. Assume that Uncle applies the equity method to account for this investment in Nephew. What is the subsidiary’s income recognized by Uncle in 2011?
b. What is the noncontrolling interest’s share of the subsidiary’s 2011 income?
Mesa, Inc., obtained 80 percent of Butte Corporation on January 1, 2009. Annual amortization of $22,500 is to be recorded on the allocations of Butte’s acquisition date business fair value. On January 1, 2010, Butte acquired 55 percent of Valley Company’s voting stock. Excess business fairvalue amortization on this second acquisition amounted to $8,000 per year. For 2011, each of the three companies reported the following information accumulated by its separate accounting system. Operating income figures do not include any investment or dividend income.
Operating Income
Dividends Paid
Mesa
$250,000
$150,000
Butte
98,000
25,000
Valley
140,000
30,000
a. What is consolidated net income for 2011?
b. How is consolidated net income distributed to the controlling and noncontrolling interests?
Baxter, Inc., owns 90 percent of Wisconsin, Inc., and 20 percent of Cleveland Company. Wisconsin, in turn, holds 60 percent of Cleveland’s outstanding stock. No excess amortization resulted from these acquisitions. During the current year, Cleveland sold a variety of inventory items to Wisconsin for $40,000 although the original cost was $30,000. Of this total, Wisconsin still held $12,000 in inventory (at transfer price) at year end.
During this same period, Wisconsin sold merchandise to Baxter for $100,000 although the original cost was only $70,000. At year end, $40,000 of these goods (at the transfer price) was still on hand.
The initial value method was used to record each of these investments. None of the companies holds any other investments. Using the following separate income statements, determine the figures that would appear on a consolidated income statement:
Fontana Company developed a specialized banking application software program that it licenses to various financial institutions through multiple year agreements. On January 1, 2011, these licensing agreements have a fair value of $750,000 and represent Fontana’s sole asset. Although Fontana currently has no liabilities, because of recent operating losses, the company has a $120,000 net operating loss (NOL) carryforward.
On January 1, 2011, Catalan, Inc., acquired all of Fontana’s voting stock for $900,000. Catalan expects to extract operating synergies by integrating Fontana’s software into its own products. Catalan also hopes that Fontana will be able to receive a future tax reduction from its NOL. Assume an applicable federal income tax rate of 35 percent.
a. If there is a greater than 50 percent chance that the subsidiary will be able to utilize the NOL carryforward, how much goodwill should Catalan recognize from the acquisition?
b. If there is a less than 50 percent chance that the subsidiary will be able to utilize the NOL carryforward, how much goodwill should Catalan recognize from the acquisition?
Up and its 80 percent owned subsidiary (Down) reported the following figures for the year ending December 31, 2011. Down paid dividends of $30,000 during this period.
Up
Down
Sales . . . . . . . . .
($600,000)
($300,000)
Cost of goods sold
300,000
140,000
Operating expenses
174,000
60,000
Dividend income
24,000
–0–
Net income . .
($150,000)
($100,000)
In 2010, unrealized gains of $30,000 on upstream transfers of $90,000 were deferred into 2011.
In 2011, unrealized gains of $40,000 on upstream transfers of $110,000 were deferred into 2012.
a. What figures appear in a consolidated income statement?
b. What income tax expense should appear on the consolidated income statement if each company files a separate return? Assume that the tax rate is 30 percent.
The controller of Dugan Industries has collected the following monthly expense data for use in analyzing the cost behavior of maintenance costs.
Total
Total
Month
Maintenance Costs
Machine Hours
January
$2,400
300
February
3,000
400
March
3,600
600
April
4,500
790
May
3,200
500
June
4,900
800
Instructions
(a) Determine the fixed and variable cost components using the high low method.
(b) Prepare a graph showing the behavior of maintenance costs, and identify the fixed and variable cost elements. Use 200 unit increments and $1,000 cost increments.
Titus Equipment Company manufactures and distributes industrial air compressors.
The following costs are available for the year ended December 31, 2010.The company has no beginning inventory. In 2010, 1,500 units were produced, but only 1,300 units were sold. The unit selling price was $4,500. Costs and expenses were:
Variable costs per unit
Direct materials
$ 1,000
Direct labor
1,500
Variable manufacturing overhead
300
Variable selling and administrative expenses
70
Annual fixed costs and expenses
Manufacturing overhead
$1,400,000
Selling and administrative expenses
100,000
Instructions
(a) Compute the manufacturing cost of one unit of product using variable costing.
(b) Prepare a 2010 income statement for Titus Company using variable costing.
Matt Reiss owns the Fredonia Barber Shop. He employs five barbers and pays each a base rate of $1,000 per month. One of the barbers serves as the manager and receives an extra $500 per month. In addition to the base rate, each barber also receives a commission of $5.50 per haircut. Other costs are as follows.
Advertising
$200 per month
Rent
$900 per month
Barber supplies
$0.30 per haircut
Utilities
$175 per month plus $0.20 per haircut
Magazines
$25 per month
Matt currently charges $10 per haircut.
Instructions
(a) Determine the variable cost per haircut and the total monthly fixed costs.
(b) Compute the break even point in units and dollars.
(c) Prepare a CVP graph, assuming a maximum of 1,800 haircuts in a month. Use increments of 300 haircuts on the horizontal axis and $3,000 on the vertical axis.
(d) Determine net income, assuming 1,900 haircuts are given in a month.
Utech Company bottles and distributes Livit, a diet soft drink. The beverage is sold for 50 cents per 16 ounce bottle to retailers, who charge customers 75 cents per bottle. For the year 2010, management estimates the following revenues and costs.
Net sales
$1,800,000
Selling expenses—variable
$70,000
Direct materials
430,000
Selling expenses—fixed
65,000
Direct labor
352,000
Administrative expenses—
Manufacturing overhead—
variable
20,000
variable
316,000
Administrative expenses—
Manufacturing overhead—
fixed
60,000
fixed
283,000
Instructions
(a) Prepare a CVP income statement for 2010 based on management’s estimates.
(b) Compute the break even point in (1) units and (2) dollars.
(c) Compute the contribution margin ratio and the margin of safety ratio. (Round to full percents.)
(d) Determine the sales dollars required to earn net income of $238,000.
Gorham Manufacturing’s sales slumped badly in 2010. For the first time in its history, it operated at a loss. The company’s income statement showed the following results from selling 600,000 units of product: Net sales $2,400,000; total costs and expenses $2,540,000; and net loss $140,000. Costs and expenses consisted of the amounts shown below.
Total
Variable
Fixed
Cost of goods sold
$2,100,000
$1,440,000
$660,000
Selling expenses
240,000
72,000
168,000
Administrative expenses
200,000
48,000
152,000
$2,540,000
$1,560,000
$980,000
Management is considering the following independent alternatives for 2011.
1. Increase unit selling price 20% with no change in costs, expenses, and sales volume.
2. Change the compensation of salespersons from fixed annual salaries totaling $150,000 to total salaries of $60,000 plus a 3% commission on net sales.
3. Purchase new automated equipment that will change the proportion between variable and fixed cost of goods sold to 54% variable and 46% fixed.
Instructions
(a) Compute the break even point in dollars for 2010.
(b) Compute the break even point in dollars under each of the alternative courses of action. (Round all ratios to nearest full percent.) Which course of action do you recommend?
Alice Shoemaker is the advertising manager for Value Shoe Store. She is currently working on a major promotional campaign. Her ideas include the installation of a new lighting system and increased display space that will add $34,000 in fixed costs to the $270,000 currently spent. In addition, Alice is proposing that a 5% price decrease ($40 to $38) will produce a 20% increase in sales volume (20,000 to 24,000). Variable costs will remain at $22 per pair of shoes.
Management is impressed with Alice’s ideas but concerned about the effects that these changes will have on the break even point and the margin of safety.
Instructions
(a) Compute the current break even point in units, and compare it to the break even point in units if Alice’s ideas are used.
(b) Compute the margin of safety ratio for current operations and after Alice’s changes are introduced. (Round to nearest full percent.)
(c) Prepare a CVP income statement for current operations and after Alice’s changes are introduced. Would you make the changes suggested?
Poole Corporation has collected the following information after its first year of sales.
Net sales were $1,600,000 on 100,000 units; selling expenses $240,000 (40% variable and 60% fixed); direct materials $511,000; direct labor $285,000; administrative expenses $280,000 (20% variable and 80% fixed); manufacturing overhead $360,000 (70% variable and 30% fixed). Top management has asked you to do a CVP analysis so that it can make plans for the coming year. It has projected that unit sales will increase by 10% next year.
Instructions
(a) Compute (1) the contribution margin for the current year and the projected year, and (2) the fixed costs for the current year. (Assume that fixed costs will remain the same in the projected year.)
(b) Compute the break even point in units and sales dollars for the current year.
(c) The company has a target net income of $310,000.What is the required sales in dollars for the company to meet its target?
(d) If the company meets its target net income number, by what percentage could its sales fall before it is operating at a loss? That is, what is its margin of safety ratio?
(e) The company is considering a purchase of equipment that would reduce its direct labor costs by $104,000 and would change its manufacturing overhead costs to 30% variable and 70% fixed (assume total manufacturing overhead cost is $360,000, as above). It is lso considering switching to a pure commission basis for its sales staff. This would change selling expenses to 90% variable and 10% fixed (assume total selling expense is $240,000, as above). Assuming that net sales remain at first year levels, compute (1) the contribution margin and (2) the contribution margin ratio, and recompute (3) the break even point in sales dollars. Comment on the effect each of management’s proposed changes has on the break even point.
TLR produces plastic that is used for injection molding applications such as gears for small motors. In 2010, the first year of operations, TLR produced 6,000 tons of plastic and sold 5,000 tons. In 2011, the production and sales results were exactly reversed. In each year, selling price per ton was $1,000, variable manufacturing costs were 15% of the sales price of units produced, variable selling expenses were 10% of the selling price of units sold, fixed manufacturing costs were $2,100,000, and fixed administrative expenses were $500,000.
Instructions (a) Prepare comparative income statements for each year using variable costing.
(b) Prepare comparative income statements for each year using absorption costing.
(c) Reconcile the differences each year in income from operations under the two costing approaches.
(d) Comment on the effects of production and sales on net income under the two costing approaches.
The McCune Barber Shop employs four barbers. One barber, who also serves as the manager, is paid a salary of $3,900 per month. The other barbers are paid $1,900 per month. In addition, each barber is paid a commission of $2 per haircut. Other monthly costs are: store rent $700 plus 60 cents per haircut, depreciation on equipment $500, barber supplies 40 cents per haircut, utilities $300, and advertising $100.The price of a haircut is $10.
Instructions
(a) Determine the variable cost per haircut and the total monthly fixed costs.
(b) Compute the break even point in units and dollars.
(c) Prepare a CVP graph, assuming a maximum of 1,800 haircuts in a month. Use increments of 300 haircuts on the horizontal axis and $3,000 increments on the vertical axis.
(d) Determine the net income, assuming 1,700 haircuts are given in a month.
Huber Company bottles and distributes No FIZZ, a fruit drink.The beverage is sold for 50 cents per 16 ounce bottle to retailers, who charge customers 70 cents per bottle. For the year 2010, management estimates the following revenues and costs.
Net sales
$2,000,000
Selling expenses—variable
$ 80,000
Direct materials
360,000
Selling expenses—fixed
150,000
Direct labor
450,000
Administrative expenses—
Manufacturing overhead—
variable
40,000
variable
270,000
Administrative expenses—
Manufacturing overhead—
fixed
70,000
fixed
280,000
Instructions
(a) Prepare a CVP income statement for 2010 based on management’s estimates.
(b) Compute the break even point in (1) units and (2) dollars.
(c) Compute the contribution margin ratio and the margin of safety ratio.
(d) Determine the sales dollars required to earn net income of $390,000.
Ace Company reports current earnings of $400,000 while paying $40,000 in cash dividends. Byrd Company earns $100,000 in net income and distributes $10,000 in dividends. Ace has held a 70 percent interest in Byrd for several years, an investment with an acquisition date fair value equal to the book value of its underlying net assets. Ace uses the initial value method to account for these shares. On January 1 of the current year, Byrd acquired in the open market $50,000 of Ace’s 8 percent bonds. The bonds had originally been issued several years ago for 92, reflecting a 10 percent effective interest rate. On the date of purchase, the book value of the bonds payable was $48,300. Byrd paid $46,600 based on a 12 percent effective interest rate over the remaining life of the bonds.
On January 1, Tesco Company spent a total of $4,384,000 to acquire control over Blondel Company. This price was based on paying $424,000 for 20 percent of Blondel’s preferred stock and $3,960,000 for 90 percent of its outstanding common stock. At the acquisition date, the fair value of the 10 percent noncontrolling interest in Blondel’s common stock was $440,000. The fair value of the 80 percent of Blondel’s preferred shares not owned by Tesco was $1,696,000. Blondel’s stockholders’ equity accounts at January 1 were as follows:
Preferred stock—9%, $100 par value, cumulative and participating; 10,000 shares outstanding
$1,000,000
Common stock—$50 par value; 40,000 shares outstanding
2,000,000
Retained earnings
3,000,000
Total stockholders’ equity
$6,000,000
Tesco believes that all of Blondel’s accounts approximate their fair values within the company’s financial statements. What amount of consolidated goodwill should be recognized?
On January 1, Morgan Company has a net book value of $1,460,000 as follows:
1,000 shares of preferred stock; par value $100 per share; cumulative, nonparticipating, nonvoting; call value $108 per share
$ 100,000
20,000 shares of common stock; par value $40 per share
800,000
Retained earnings
560,000
Total
$1,460,000
Leinen Company acquires all outstanding preferred shares for $106,000 and 60 percent of the common stock for $870,000. The acquisition date fair value of the noncontrolling interest in Morgan’s common stock was $580,000. Leinen believed that one of Morgan’s buildings, with a 12 year life, was undervalued by $50,000 on the company’s financial records. What amount of consolidated goodwill would be recognized from this acquisition?
Neill Company purchases 80 percent of the common stock of Stamford Company on January 1, 2010, when Stamford has the following stockholders’ equity accounts:
Common stock—40,000 shares outstanding
$100,000
Additional paid in capital
75,000
Retained earnings, 1/1/10
540,000
Total stockholders’ equity
$715,000
To acquire this interest in Stamford, Neill pays a total of $592,000. The acquisition date fair value of the 20 percent noncontrolling interest was $148,000. Any excess fair value was allocated to goodwill, which has not experienced any impairment.
On January 1, 2011, Stamford reports retained earnings of $620,000. Neill has accrued the increase in Stamford’s retained earnings through application of the equity method. View the following problems as independent situations:
The following describes a set of arrangements between TecPC Company and a variable interest entity (VIE) as of December 31, 2011. TecPC agrees to design and construct a new research and development (R&D) facility. The VIE’s sole purpose is to finance and own the R&D facility and lease it to TecPC Company after construction is completed. Payments under the operating lease are expected to begin in the first quarter of 2013.
The VIE has financing commitments sufficient for the construction project from equity and debt participants (investors) of $4 million and $42 million, respectively. TecPC, in its role as the VIE’s construction agent, is responsible for completing construction by December 31, 2012. TecPC has guaranteed a portion of the VIE’s obligations during the construction and post construction periods.
TecPC agrees to lease the R&D facility for five years with multiple extension options. The lease is a variable rate obligation indexed to a three month market rate. As market interest rates increase or decrease, the payments under this operating lease also increase or decrease, sufficient to provide a return to the investors. If all extension options are exercised, the total lease term is 35 years. At the end of the first five year lease term or any extension, TecPC may choose one of the following:
• Renew the lease at fair value subject to investor approval.
• Purchase the facility at its original construction cost.
• Sell the facility on the VIE’s behalf, to an independent third party. If TecPC sells the project and the proceeds from the sale are insufficient to repay the investors their original cost, TecPC may be required to pay the VIE up to 85 percent of the project’s cost.
a. What is the purpose of reporting consolidated statements for a company and the entities that it controls?
b. When should a VIE’s financial statements be consolidated with those of another company?
c. Identify the risks of ownership of the R&D facility that (1) TecPC has effectively shifted to the VIE’s owners and (2) remain with TecPC.
d. What characteristics of a primary beneficiary does TecPC possess?
Highlight, Inc., owns all outstanding stock of Kiort Corporation. The two companies report the following balances for the year ending December 31, 2011:
Alford Company and its 80 percent–owned subsidiary, Knight, have the following income statements for 2011:
Alford
Knight
Revenues
$(500,000)
$(230,000)
Cost of goods sold
300,000
140,000
Depreciation and amortization
40,000
10,000
Other expenses
20,000
20,000
Gain on sale of equipment
(30,000)
–0–
Equity in earnings of Knight
(36,200)
–0–
Net income
$(206,200)
$ (60,000)
• Intra entity inventory transfers during the year amounted to $90,000 and were downstream from Alford to Knight.
• Unrealized inventory gains at January 1 were $6,000, but at December 31, they are $9,000.
• Annual excess amortization expense resulting from the acquisition is $11,000.
• Knight paid dividends totaling $20,000.
• The noncontrolling interest’s share of the subsidiary’s income is $9,800.
• During the year, consolidated inventory rose by $11,000 while accounts receivable and accounts payable declined by $8,000 and $6,000, respectively.
Using either the direct or the indirect approach, determine the amount of cash generated from operations during the period by this business combination.
Porter Corporation owns all 30,000 shares of the common stock of Street, Inc. Porter has 60,000 shares of its own common stock outstanding. During the current year, Porter earns income (without any consideration of its investment in Street) of $150,000 while Street reports $130,000. Annual amortization of $10,000 is recognized each year on the consolidation worksheet based on acquisitiondate fair value allocations. Both companies have convertible bonds outstanding. During the current year, interest expense (net of taxes) is $32,000 for Porter and $24,000 for Street. Porter’s bonds can be converted into 8,000 shares of common stock; Street’s bonds can be converted into 10,000 shares. Porter owns none of these bonds. What are the earnings per share amounts that Porter should report in its current year consolidated income statement?
The following separate income statements are for Mason and its 80 percent–owned subsidiary, Dixon:
Mason
Dixon
Revenues
$(400,000)
$(300,000)
Expenses
290,000
225,000
Gain on sale of equipment
–0–
(15,000)
Equity earnings of subsidiary
(52,000)
–0–
Net income
$(162,000)
$ (90,000)
Outstanding common shares
50,000
30,000
Additional Information
• Amortization expense resulting from Dixon’s excess acquisition date fair value is $25,000 per year.
• Mason has convertible preferred stock outstanding. Each of these 5,000 shares is paid a dividend of $4 per year. Each share can be converted into four shares of common stock.
• Stock warrants to buy 10,000 shares of Dixon are also outstanding. For $20, each warrant can be converted into a share of Dixon’s common stock. The fair value of this stock is $25 throughout the year. Mason owns none of these warrants.
• Dixon has convertible bonds payable that paid interest of $30,000 (after taxes) during the year. These bonds can be exchanged for 20,000 shares of common stock. Mason holds 15 percent of these bonds, which it bought at book value directly from Dixon.
Albuquerque, Inc., acquired 16,000 shares of Marmon Company several years ago for $600,000. At the acquisition date, Marmon reported a book value of $710,000, and Albuquerque assessed the fair value of the noncontrolling interest at $150,000. Any excess of acquisition date fair value over book value was assigned to broadcast licenses with indefinite lives. Since the acquisition date and until this point, Marmon has issued no additional shares. No impairment has been recognized for the broadcast licenses.
At the present time, Marmon reports $800,000 as total stockholders’ equity, which is broken down as follows:
Common stock ($10 par value)
$200,000
Additional paid in capital
230,000
Retained earnings
370,000
Total
$800,000
View the following as independent situations:
a. Marmon sells 5,000 shares of previously unissued common stock to the public for $47 per share. Albuquerque purchased none of this stock. What journal entry should Albuquerque make to recognize the impact of this stock transaction?
b. Marmon sells 4,000 shares of previously unissued common stock to the public for $33 per share. Albuquerque purchased none of this stock. What journal entry should Albuquerque make to recognize the impact of this stock transaction?
On January 1, 2009, Aronsen Company acquired 90 percent of Siedel Company’s outstanding shares. Siedel had a net book value on that date of $480,000: common stock ($10 par value) of $200,000 and retained earnings of $280,000.
Aronsen paid $584,100 for this investment. The acquisition date fair value of the 10 percent noncontrolling interest was $64,900. The excess fair value over book value associated with the acquisition was used to increase land by $89,000 and to recognize copyrights (16 year remaining life) at $80,000. Subsequent to the acquisition, Aronsen applied the initial value method to its investment account.
In the 2009–2010 period, the subsidiary’s retained earnings increased by $100,000. During 2011, Siedel earned income of $80,000 while paying $20,000 in dividends. Also, at the beginning of 2011, Siedel issued 4,000 new shares of common stock for $38 per share to finance the expansion of its corporate facilities. Aronsen purchased none of these additional shares and therefore recorded no entry. Prepare the appropriate 2011 consolidation entries for these two companies.
On January 1, 2010, Mona, Inc., acquired 80 percent of Lisa Company’s common stock as well as 60 percent of its preferred shares. Mona paid $65,000 in cash for the preferred stock, with a call value of 110 percent of the $50 per share par value. The remaining 40 percent of the preferred shares traded at a $34,000 fair value. Mona paid $552,800 for the common stock. At the acquisition date, the noncontrolling interest in the common stock had a fair value of $138,200. The excess fair value over Lisa’s book value was attributed to franchise contracts of $40,000. This intangible asset is being amortized over a 40 year period. Lisa pays all preferred stock dividends (a total of $8,000 per year) on an annual basis. During 2010, Lisa’s book value increased by $50,000.
On January 2, 2010, Mona acquired one half of Lisa’s outstanding bonds payable to reduce the business combination’s debt position. Lisa’s bonds had a face value of $100,000 and paid cash interest of 10 percent per year. These bonds had been issued to the public to yield 14 percent. Interest is paid each December 31. On January 2, 2010, these bonds had a total $88,350 book value. Mona paid $53,310, indicating an effective interest rate of 8 percent.
On January 3, 2010, Mona sold Lisa fixed assets that had originally cost $100,000 but had accumulated depreciation of $60,000 when transferred. The transfer was made at a price of $120,000. These assets were estimated to have a remaining useful life of 10 years.
The individual financial statements for these two companies for the year ending December 31, 2011, are as follows:
Mona, Inc
Lisa Company
Sales and other revenues
$ (500,000)
$ (200,000)
Expenses
220,000
120,000
Dividend income—Lisa common stock
(8,000)
–0–
Dividend income—Lisa preferred stock
(4,800)
–0–
Net income
$ (292,800)
$ (80,000)
Retained earnings, 1/1/11
$ (700,000)
$ (500,000)
Net income (above)
(292,800)
(80,000)
Dividends paid—common stock
92,800
10,000
Dividends paid—preferred stock
–0–
8,000
Retained earnings, 12/31/11
$ (900,000)
$ (562,000)
Current assets
$ 130,419
$ 500,000
Investment in Lisa—common stock
552,800
–0–
Investment in Lisa—preferred stock
65,000
–0–
Investment in Lisa—bonds
51,781
–0–
Fixed assets
1,100,000
800,000
Accumulated depreciation
(300,000)
(200,000)
Total assets
$ 1,600,000
$ 1,100,000
Accounts payable
$ (400,000)
$ (144,580)
Bonds payable
–0–
(100,000)
Discount on bonds payable
–0–
6,580
Common stock
(300,000)
(200,000)
Preferred stock
–0–
(100,000)
Retained earnings, 12/31/11
(900,000)
(562,000)
Total liabilities and equities
$(1,600,000)
$(1,100,000)
a. What consolidation worksheet adjustments would have been required as of January 1, 2010, to eliminate the subsidiary’s common and preferred stocks?
b. What consolidation worksheet adjustments would have been required as of December 31, 2010, to account for Mona’s purchase of Lisa’s bonds?
c. What consolidation worksheet adjustments would have been required as of December 31, 2010, to account for the intra entity sale of fixed assets?
d. Assume that consolidated financial statements are being prepared for the year ending December 31, 2011. Calculate the consolidated balance for each of the following accounts:
Rodriguez Company holds 80 percent of the common stock of Molina, Inc., and 30 percent of this subsidiary’s convertible bonds. The following consolidated financial statements are for 2010 and 2011:
Rodriguez Company and Consolidated Subsidiary Molina
2010
2011
Revenues
$ (850,000)
$ (980,000)
Cost of goods sold
600,000
640,000
Depreciation and amortization
90,000
100,000
Gain on sale of building
–0–
(20,000)
Interest expense
30,000
30,000
Consolidated net income
(130,000)
(230,000)
to noncontrolling interest
9,000
11,000
to parent company
$ (121,000)
$ (219,000)
Retained earnings, 1/1
$ (300,000)
$ (371,000)
Net income
(121,000)
(219,000)
Dividends paid
50,000
100,000
Retained earnings, 12/31
$ (371,000)
$ (490,000)
Cash
$ 80,000
$ 150,000
Accounts receivable
150,000
140,000
Inventory
200,000
340,000
Buildings and equipment (net)
640,000
690,000
Databases
150,000
145,000
Total assets
$ 1,220,000
$ 1,465,000
Accounts payable
$ (140,000)
$ (100,000)
Bonds payable
(400,000)
(500,000)
Noncontrolling interest in Molina
(32,000)
(41,000)
Common stock
(100,000)
(130,000)
Additional paid in capital
(177,000)
(204,000)
Retained earnings
(371,000)
(490,000)
Total liabilities and equities
$(1,220,000)
$(1,465,000)
Additional Information for 2011
• The parent issued bonds during the year for cash.
• Amortization of databases amounts to $5,000 per year.
• The parent sold a building with a cost of $60,000 but a $30,000 book value for cash on May 11.
• The subsidiary purchased equipment on July 23 using cash.
• Late in November, the parent issued stock for cash.
• During the year, the subsidiary paid dividends of $10,000.
Prepare a consolidated statement of cash flows for this business combination for the year ending
December 31, 2011. Either the direct or the indirect approach may be used.
Following are separate income statements for Austin, Inc., and its 80 percent owned subsidiary, Rio Grande Corporation as well as a consolidated statement for the business combination as a whole.
Austin
Rio Grande
Consolidated
Revenues
$(700,000)
$(500,000)
$(1,200,000)
Cost of goods sold
400,000
300,000
700,000
Operating expenses
100,000
70,000
195,000
Equity in earnings of Rio Grande
(84,000)
Individual company net income
$(284,000)
$(130,000)
Consolidated net income
$ (305,000)
Noncontrolling interest in
Rio Grande’s income
(21,000)
Consolidated net income attributable to Austin
$ (284,000)
Additional Information
• Annual excess fair over book value amortization of $25,000 resulted from the acquisition.
• The parent applies the equity method to this investment.
• Austin has 50,000 shares of common stock and 10,000 shares of preferred stock outstanding. Owners of the preferred stock are paid an annual dividend of $40,000, and each share can be exchanged for two shares of common stock.
• Rio Grande has 30,000 shares of common stock outstanding. The company also has 5,000 stock warrants outstanding. For $10, each warrant can be converted into a share of Rio Grande’s common stock. Austin holds half of these warrants. The price of Rio Grande’s common stock was $20 per share throughout the year.
• Rio Grande also has convertible bonds, none of which Austin owned. During the current year, total interest expense (net of taxes) was $22,000. These bonds can be exchanged for 10,000 shares of the subsidiary’s common stock.
On January 1, Paisley, Inc., paid $560,000 for all of Skyler Corporation’s outstanding stock. This cash payment was based on a price of $180 per share for Skyler’s $100 par value preferred stock and $38 per share for its $20 par value common stock. The preferred shares are voting, cumulative, and fully participating. At the acquisition date, the book values of Skyler’s accounts equaled their fair values. Any excess fair value is assigned to an intangible asset and will be amortized over a 10 year period.
During the year, Skyler sold inventory costing $60,000 to Paisley for $90,000. All but $18,000 (measured at transfer price) of this merchandise has been resold to outsiders by the end of the year. At the end of the year, Paisley continues to owe Skyler for the last shipment of inventory priced at $28,000.
Also, on January 2, Paisley sold Skyler equipment for $20,000 although it had a book value of only $12,000 (original cost of $30,000). Both companies depreciate such property according to the straight line method with no salvage value. The remaining life at this date was four years. The following financial statements are for each company for the year ending December 31. Determine consolidated financial totals for this business combination.
On June 30, 2011, Plaster, Inc., paid $916,000 for 80 percent of Stucco Company’s outstanding stock. Plaster assessed the acquisition date fair value of the 20 percent noncontrolling interest at $229,000. At acquisition date, Stucco reported the following book values for its assets and liabilities:
Cash
$ 60,000
Accounts receivable
127,000
Inventory
203,000
Land
65,000
Buildings
175,000
Equipment
300,000
Accounts payable
(35,000)
On June 30, Plaster allocated the excess acquisition date fair value over book value to Stucco’s assets as follows:
Equipment (3 year life)
$ 75,000
Database (10 year life)
175,000
At the end of 2011, the following comparative (2010 and 2011) balance sheets and consolidated income statement were available:
Plaster, Inc December 31, 2010
Consolidated December 31, 2011
Cash
$ 43,000
$ 242,850
Accounts receivable (net)
362,000
485,400
Inventory
415,000
720,000
Land
300,000
365,000
Buildings (net)
245,000
370,000
Equipment (net)
1,800,000
2,037,500
Database
–0–
166,250
Total assets
$3,165,000
$4,387,000
Accounts payable
$ 80,000
$ 107,000
Long term liabilities
400,000
1,200,000
Common stock
1,800,000
1,800,000
Noncontrolling interest
–0–
255,500
Retained earnings
885,000
1,024,500
Total liabilities and equities
$3,165,000
$4,387,000
PLASTER, INC, AND SUBSIDIARY STUCCO COMPANY Consolidated Income Statement For the Year Ended December 31, 2011
Revenues
$1,217,500
Cost of goods sold
$737,500
Depreciation
187,500
Database amortization
8,750
Interest and other expenses
9,750
943,500
Consolidated net income
$ 274,000
Additional Information for 2011
• On December 1, Stucco paid a $40,000 dividend. During the year, Plaster paid $100,000 in dividends.
• During the year, Plaster issued $800,000 in long term debt at par.
• Plaster reported no asset purchases or dispositions other than the acquisition of Stucco. Prepare a 2011 consolidated statement of cash flows for Plaster and Stucco. Use the indirect method of reporting cash flows from operating activities.
Place Company owns a majority voting interest in Sassano, Inc. On January 1, 2009, Place issued $1,000,000 of 11 percent 10 year bonds at $943,497.77 to yield 12 percent. On January 1, 2011, Sassano purchased all of these bonds in the open market at a price of $904,024.59 with an effective yield of 13 percent.
Required
Using an Excel spreadsheet, do the following:
1. Prepare amortization schedules for the Place Company bonds payable and the Investment in Place Bonds for Sassano, Inc.
2. Using the values from the amortization schedules, compute the worksheet adjustment for a December 31, 2011, consolidation of Place and Sassano to reflect the effective retirement of the Place bonds. Formulate your solution to be able to accommodate various yield rates (and therefore prices) on the repurchase of the bonds.
Find a recent annual report for a firm with business acquisitions (e.g., Compaq, GE). Locate the firm’s consolidated statement of cash flows and answer the following:
• Does the firm employ the direct or indirect method of accounting for operating cash flows?
• How does the firm account for the balances in balance sheet operating accounts (e.g., accounts receivable, inventory, accounts payable) in determining operating cash flows?
• Describe the accounting for cash paid for business acquisitions in the statement of cash flows.
• Describe the accounting for any noncontrolling subsidiary interest, acquired in process research and development costs, and any other business combination–related items in the consolidated statement of cash flows.
On January 1, a subsidiary buys 10 percent of the outstanding shares of its parent company. Although the total book value and fair value of the parent’s net assets were $4 million, the price paid for these shares was $420,000. An intangible asset is amortized in this business combination over a 40 year period. During the year, the parent reported $510,000 of operational income (no investment income was included) and paid dividends of $140,000. How are these shares reported at December 31?
a. The investment is recorded as $457,000 and then eliminated for consolidation purposes.
b. Consolidated stockholders’ equity is reduced by $457,000.
c. The investment is recorded as $456,500 and then eliminated for consolidation purposes.
d. Consolidated stockholders’ equity is reduced by $420,000.
Bassett Company owns 80 percent of Crimson and Crimson owns 90 percent of Damson, Inc. Operational income totals for the current year follow; they contain no investment income. None of these acquisitions required amortization expense. Included in Damson’s income is a $40,000 unrealized gain on intra entity transfers to Crimson.
Bassett
Crimson
Damson
Operational income
$300,000
$200,000
$200,000
What is Bassett’s accrual based income for the year?
Smith Corporation acquired 80 percent of the outstanding voting stock of Kane, Inc., on January 1, 2010, when Kane had a net book value of $400,000. Any excess fair value was assigned to intangible assets and amortized at a rate of $5,000 per year.
Reported net income for 2011 was $300,000 for Smith and $110,000 for Kane. Smith distributed $100,000 in dividends during this period; Kane paid $40,000. At year end, selected figures from the two companies’ balance sheets were as follows:
Smith Corporation
Kane, Inc
Inventory
$140,000
$ 90,000
Land
600,000
200,000
Equipment (net)
400,000
300,000
Common stock
400,000
200,000
Retained earnings, 12/31/11
600,000
400,000
During 2010, intra entity sales of $90,000 (original cost of $54,000) were made. Only 20 percent of this inventory was still held at the end of 2010. In 2011, $120,000 in intra entity sales were made with an original cost of $66,000. Of this merchandise, 30 percent had not been resold to outside parties by the end of the year.
Each of the following questions should be considered as an independent situation.
a. If the intra entity sales were upstream, what is the noncontrolling interest’s share of the subsidiary’s 2011 net income?
b. What is the consolidated balance in the ending Inventory account?
c. If the intra entity sales were downstream, what is the noncontrolling interest’s share of the subsidiary’s 2011 net income?
d. If the intra entity sales were downstream, what is the consolidated net income? Assume that Smith uses the initial value method to account for this investment.
e. If the intra entity sales were downstream, what is the consolidated balance of the Retained Earnings account as of the end of 2011? Assume that Smith uses the partial equity method to account for this investment.
f. If the intra entity sales were upstream, what is the consolidated balance for Retained Earnings as of the end of 2011? Assume that Smith uses the partial equity method to account for this investment.
g. Assume that no intra entity inventory sales occurred between Smith and Kane. Instead, in 2010, Kane sold land costing $30,000 to Smith for $50,000. On the 2011 consolidated balance sheet, what value should be reported for land?
h. Assume that no intra entity inventory or land sales occurred between Smith and Kane. Instead, on January 1, 2010, Kane sold equipment (that originally cost $100,000 but had a $60,000 book value on that date) to Smith for $80,000. At the time of sale, the equipment had a remaining useful life of five years. What worksheet entries are made for a December 31, 2011, consolidationof these two companies to eliminate the impact of the intra entity transfer? For 2011, what is the noncontrolling interest’s share of Kane’s net income?
On January 1, 2010, Doone Corporation acquired 60 percent of the outstanding voting stock of Rockne Company for $300,000 consideration. At the acquisition date, the fair value of the 40 percent noncontrolling interest was $200,000 and Rockne’s assets and liabilities had a collective net fair value of $500,000. Doone uses the equity method in its internal records to account for its investment in Rockne. Rockne reports net income of $160,000 in 2011. Since being acquired, Rockne has regularly supplied inventory to Doone at 25 percent more than cost. Sales to Doone amounted to $250,000 in 2010 and $300,000 in 2011. Approximately 30 percent of the inventory purchased during any one year is not used until the following year.
a. What is the noncontrolling interest’s share of Rockne’s 2011 income?
b. Prepare Doone’s 2011 consolidation entries required by the intra entity inventory transfers.
Penguin Corporation acquired 80 percent of the outstanding voting stock of Snow Company on January 1, 2010, for $420,000 in cash and other consideration. At the acquisition date, Penguin assessed Snow’s identifiable assets and liabilities at a collective net fair value of $525,000 and the fair value of the 20 percent noncontrolling interest was $105,000. No excess fair value over book value amortization accompanied the acquisition.
The following selected account balances are from the individual financial records of these two companies as of December 31, 2011:
Penguin
Snow
Sales
$640,000
$360,000
Cost of goods sold
290,000
197,000
Operating expenses
150,000
105,000
Retained earnings, 1/1/11
740,000
180,000
Inventory
346,000
110,000
Buildings (net)
358,000
157,000
Investment income
Not given
–0–
a. Assume that Penguin sells Snow inventory at a markup equal to 40 percent of cost. Intra entity transfers were $90,000 in 2010 and $110,000 in 2011. Of this inventory, Snow retained and then sold $28,000 of the 2010 transfers in 2011 and held $42,000 of the 2011 transfers until 2012. On consolidated financial statements for 2011, determine the balances that would appear for the following accounts:
Cost of Goods Sold
Inventory
Noncontrolling Interest in Subsidiary’s Net Income
b. Assume that Snow sells inventory to Penguin at a markup equal to 40 percent of cost. Intra entity transfers were $50,000 in 2010 and $80,000 in 2011. Of this inventory, $21,000 of the 2010 transfers were retained and then sold by Penguin in 2011, whereas $35,000 of the 2011 transfers were held until 2012.
On consolidated financial statements for 2011, determine the balances that would appear for the following accounts:
Cost of Goods Sold
Inventory
Noncontrolling Interest in Subsidiary’s Net Income
c. Penguin sells Snow a building on January 1, 2010, for $80,000, although its book value was only $50,000 on this date. The building had a five year remaining life and was to be depreciated using the straight line method with no salvage value.
Determine the balances that would appear on consolidated financial statements for 2011 for Buildings (net)
Operating Expenses
Noncontrolling Interest in Subsidiary’s Net Income
Akron, Inc., owns all outstanding stock of Toledo Corporation. Amortization expense of $15,000 per year for patented technology resulted from the original acquisition. For 2011, the companies had the following account balances:
Akron
Toledo
Sales
$1,100,000
$600,000
Cost of goods sold
500,000
400,000
Operating expenses
400,000
220,000
Investment income
Not given
–0–
Dividends paid
80,000
30,000
Intra entity sales of $320,000 occurred during 2010 and again in 2011. This merchandise cost $240,000 each year. Of the total transfers, $70,000 was still held on December 31, 2010, with $50,000 unsold on December 31, 2011.
a. For consolidation purposes, does the direction of the transfers (upstream or downstream) affect the balances to be reported here?
b. Prepare a consolidated income statement for the year ending December 31, 2011.
On January 1, 2011, Slaughter sold equipment to Bennett (a wholly owned subsidiary) for $120,000 in cash. The equipment had originally cost $100,000 but had a book value of only $70,000 when transferred. On that date, the equipment had a five year remaining life. Depreciation expense is computed using the straight line method.
Slaughter earned $220,000 in net income in 2011 (not including any investment income) while Bennett reported $90,000. Slaughter attributed any excess acquisition date fair value to Bennett’s unpatented technology, which was amortized at a rate of $8,000 per year.
a. What is the consolidated net income for 2011?
b. What is the parent’s share of consolidated net income for 2011 if Slaughter owns only 90 percent of Bennett?
c. What is the parent’s share of consolidated net income for 2011 if Slaughter owns only 90 percent of Bennett and the equipment transfer was upstream?
d. What is the consolidated net income for 2012 if Slaughter reports $240,000 (does not include investment income) and Bennett $100,000 in income? Assume that Bennett is a wholly owned subsidiary and the equipment transfer was downstream.
Anchovy acquired 90 percent of Yelton on January 1, 2009. Of Yelton’s total acquisition date fair value, $60,000 was allocated to undervalued equipment (with a 10 year life) and $80,000 was attributed to franchises (to be written off over a 20 year period).
Since the takeover, Yelton has transferred inventory to its parent as follows:
Year
Cost
Transfer Price
Remaining at Year End
2009
$20,000
$ 50,000
$20,000 (at transfer price)
2010
49,000
70,000
30,000 (at transfer price)
2011
50,000
100,000
40,000 (at transfer price)
On January 1, 2010, Anchovy sold Yelton a building for $50,000 that had originally cost $70,000but had only a $30,000 book value at the date of transfer. The building is estimated to have a fiveyear remaining life (straight line depreciation is used with no salvage value).
Selected figures from the December 31, 2011, trial balances of these two companies are as follows:
Anchovy
Yelton
Sales
$600,000
$500,000
Cost of goods sold
400,000
260,000
Operating expenses
120,000
80,000
Investment income
Not given
–0–
Inventory
220,000
80,000
Equipment (net)
140,000
110,000
Buildings (net)
350,000
190,000
Determine consolidated totals for each of these account balances.
On January 1, 2011, Sledge had common stock of $120,000 and retained earnings of $260,000. During that year, Sledge reported sales of $130,000, cost of goods sold of $70,000, and operating expenses of $40,000.
On January 1, 2009, Percy, Inc., acquired 80 percent of Sledge’s outstanding voting stock. At that date, $60,000 of the acquisition date fair value was assigned to unrecorded contracts (with a 20 year life) and $20,000 to an undervalued building (with a 10 year life).
In 2010, Sledge sold inventory costing $9,000 to Percy for $15,000. Of this merchandise, Percy continued to hold $5,000 at year end. During 2011, Sledge transferred inventory costing $11,000 to Percy for $20,000. Percy still held half of these items at year end.
On January 1, 2010, Percy sold equipment to Sledge for $12,000. This asset originally cost $16,000 but had a January 1, 2010, book value of $9,000. At the time of transfer, the equipment’s remaining life was estimated to be five years.
Percy has properly applied the equity method to the investment in Sledge.
a. Prepare worksheet entries to consolidate these two companies as of December 31, 2011.
b. Compute the noncontrolling interest in the subsidiary’s income for 2011.
Pitino acquired 90 percent of Brey’s outstanding shares on January 1, 2009, in exchange for $342,000 in cash. The subsidiary’s stockholders’ equity accounts totaled $326,000 and the noncontrolling interest had a fair value of $38,000 on that day. However, a building (with a nine year remaining life) in Brey’s accounting records was undervalued by $18,000. Pitino assigned the rest of the excess fair value over book value to Brey’s patented technology (six year remaining life). Brey reported net income from its own operations of $64,000 in 2009 and $80,000 in 2010. Brey paid dividends of $19,000 in 2009 and $23,000 in 2010. Brey sells inventory to Pitino as follows:
Year
Cost to Brey
Transfer Price to Pitino
Inventory Remaining at Year End (at transfer price)
2009
$69,000
$115,000
$25,000
2010
81,000
135,000
37,500
2011
92,800
160,000
50,000
At December 31, 2011, Pitino owes Brey $16,000 for inventory acquired during the period. The following separate account balances are for these two companies for December 31, 2011, and the year then ended. Credits are indicated by parentheses.
Pitino
Brey
Sales revenues
$ (862,000)
$(366,000)
Cost of goods sold
515,000
209,000
Expenses
185,400
67,000
Investment income—Brey
(68,400)
–0–
Net income
$ (230,000)
$ (90,000)
Retained earnings, 1/1/11
$ (488,000)
$(278,000)
Net income (above)
(230,000)
(90,000)
Dividends paid
136,000
27,000
Retained earnings, 12/31/11
$ (582,000)
$(341,000)
Cash and receivables
$ 146,000
$ 98,000
Inventory
255,000
136,000
Investment in Brey
450,000
–0–
Land, buildings, and equipment (net)
964,000
328,000
Total assets
$ 1,815,000
$ 562,000
Liabilities
$ (718,000)
$ (71,000)
Common stock
(515,000)
(150,000)
Retained earnings, 12/31/11
(582,000)
(341,000)
Total liabilities and equities
$(1,815,000)
$(562,000)
Answer each of the following questions:
a. What was the annual amortization resulting from the acquisition date fair value allocations?
b. Were the intra entity transfers upstream or downstream?
c. What unrealized gross profit existed as of January 1, 2011?
d. What unrealized gross profit existed as of December 31, 2011?
e. What amounts make up the $68,400 Investment Income—Brey account balance for 2011?
f. What was the noncontrolling interest’s share of the subsidiary’s net income for 2011?
g. What amounts make up the $450,000 Investment in Brey account balance as of December 31, 2011?
h. Prepare the 2011 worksheet entry to eliminate the subsidiary’s beginning owners’ equity balances.
i. Without preparing a worksheet or consolidation entries, determine the consolidation balances for these two companies.
Bennett acquired 70 percent of Zeigler on June 30, 2010, for $910,000 in cash. Based on Zeigler’s acquisition date fair value, an unrecorded intangible of $400,000 was recognized and is being amortized at the rate of $10,000 per year. The noncontrolling interest fair value was assessed at $390,000 at the acquisition date. The 2011 financial statements are as follows:
Bennett
Zeigler
Sales
$ (800,000)
$ (600,000)
Cost of goods sold
535,000
400,000
Operating expenses
100,000
100,000
Dividend income
(35,000)
–0–
Net income
$ (200,000)
$ (100,000)
Retained earnings, 1/1/11
$(1,300,000)
$ (850,000)
Net income
(200,000)
(100,000)
Dividends paid
100,000
50,000
Retained earnings, 12/31/11
$(1,400,000)
$ (900,000)
Cash and receivables
$ 400,000
$ 300,000
Inventory
290,000
700,000
Investment in Zeigler
910,000
–0–
Fixed assets
1,000,000
600,000
Accumulated depreciation
(300,000)
(200,000)
Totals
$ 2,300,000
$ 1,400,000
Liabilities
$ (600,000)
$ (400,000)
Common stock
(300,000)
(100,000)
Retained earnings
(1,400,000)
(900,000)
Totals
$(2,300,000)
$(1,400,000)
Bennett sold Zeigler inventory costing $72,000 during the last six months of 2010 for $120,000. At year end, 30 percent remained. Bennett sells Zeigler inventory costing $200,000 during 2011 for $250,000. At year end, 20 percent is left. With these facts, determine the consolidated balances for the accounts:
Following are financial statements for Moore Company and Kirby Company for 2011:
Moore
Kirby
Sales
$ (800,000)
$ (600,000)
Cost of goods sold
500,000
400,000
Operating and interest expenses
100,000
160,000
Net income
$ (200,000)
$ (40,000)
Retained earnings, 1/1/11
$ (990,000)
$ (550,000)
Net income
(200,000)
(40,000)
Dividends paid
130,000
–0–
Retained earnings, 12/31/11
$(1,060,000)
$ (590,000)
Cash and receivables
$ 217,000
$ 180,000
Inventory
224,000
160,000
Investment in Kirby
657,000
–0–
Equipment (net)
600,000
420,000
Buildings
1,000,000
650,000
Accumulated depreciation—buildings
(100,000)
(200,000)
Other assets
200,000
100,000
Total assets
$ 2,798,000
$ 1,310,000
Liabilities
$(1,138,000)
$ (570,000)
Common stock
(600,000)
(150,000)
Retained earnings, 12/31/11
(1,060,000)
(590,000)
Total liabilities and equity
$(2,798,000)
$(1,310,000)
• Moore purchased 90 percent of Kirby on January 1, 2010, for $657,000 in cash. On that date, the 10 percent noncontrolling interest was assessed to have a $73,000 fair value. Also at the acquisition date, Kirby held equipment (4 year remaining life) undervalued on the financial records by $20,000 and interest bearing liabilities (5 year remaining life) overvalued by $40,000. The rest of the excess fair value over book value was assigned to previously unrecognized brand names and amortized over a 10 year life.
• During 2010 Kirby earned a net income of $80,000 and paid no dividends.
• Each year Kirby sells Moore inventory at a 20 percent gross profit rate. Intra entity sales were $145,000 in 2010 and $160,000 in 2011. On January 1, 2011, 30 percent of the 2010 transfers were still on hand and, on December 31, 2011, 40 percent of the 2011 transfers remained.
• Moore sold Kirby a building on January 2, 2010. It had cost Moore $100,000 but had $90,000 in accumulated depreciation at the time of this transfer. The price was $25,000 in cash. At that time, the building had a five year remaining life. Determine all consolidated balances either computationally or by using a worksheet.
On January 1, 2010, Woods, Inc., acquired a 60 percent interest in the common stock of Scott, Inc., for $672,000. Scott’s book value on that date consisted of common stock of $100,000 and retained earnings of $220,000. Also, the Junuary 1, 2010, fair value on the 40 percent noncontrolling interest was $248,000. The subsidiary held patents (with a 10 year remaining life) that were undervalued within the company’s accounting records by $70,000 and an unrecorded customer list (15 year remaining life) assessed at a $45,000 fair value. Any remaining excess acquisition date fair value was assigned to goodwill. Since acquisition, Woods has applied the equity method to its Investment in Scott account and no goodwill impairment has occurred. Intra entity inventory sales between the two companies have been made as follows:
Year
Cost to Woods
Transfer Price to Scott
Ending Balance (at transfer price)
2010
120,000
150,000
50,000
2011
112,000
160,000
40,000
The individual financial statements for these two companies as of December 31, 2011, and the year then ended follow:
Woods, Inc
Scott, Inc
Sales
$ (700,000)
$(335,000)
Cost of goods sold
460,000
205,000
Operating expenses
188,000
70,000
Equity earnings in Scott
(28,000)
–0–
Net income
$ (80,000)
$ (60,000)
Retained earnings, 1/1/11
$ (695,000)
$(280,000)
Net income (above)
(80,000)
(60,000)
Dividends paid
45,000
15,000
Retained earnings, 12/31/11
$ (730,000)
$(325,000)
Cash and receivables
$ 248,000
$ 148,000
Inventory
233,000
129,000
Investment in Scott
411,000
–0–
Buildings (net)
308,000
202,000
Equipment (net)
220,000
86,000
Patents (net)
–0–
20,000
Total assets
$ 1,420,000
$ 585,000
Liabilities
$ (390,000)
$(160,000)
Common stock
(300,000)
(100,000)
Retained earnings, 12/31/11
(730,000)
(325,000)
Total liabilities and equities
$(1,420,000)
$(585,000)
a. Show how Woods determined the $411,000 Investment in Scott account balance. Assume that Woods defers 100 percent of downstream intra entity profits against its share of Scott’s income.
b. Prepare a consolidated worksheet to determine appropriate balances for external financial reporting as of December 31, 2011.
On January 1, 2009, Plymouth Corporation acquired 80 percent of the outstanding voting stock of Sander Company in exchange for $1,200,000 cash. At that time, although Sander’s book value was $925,000, Plymouth assessed Sander’s total business fair value at $1,500,000. Since that time, Sander has neither issued nor reacquired any shares of its own stock.
The book values of Sander’s individual assets and liabilities approximated their acquisition date fair values except for the patent account, which was undervalued by $350,000. The undervalued patents had a 5 year remaining life at the acquisition date. Any remaining excess fair value was attributed to goodwill. No goodwill impairments have occurred.
Sander regularly sells inventory to Plymouth. Below are details of the intra entity inventory sales for the past three years:
Year
Intra Entity Sales
Intra Entity Ending Inventory at Transfer Price
Gross Profit Rate on Intra Entity Inventory Transfers
2009
$125,000
$ 80,000
25%
2010
220,000
125,000
28%
2011
300,000
160,000
25%
Separate financial statements for these two companies as of December 31, 2011, follow:
Plymouth
Sander
Revenues
$(1,740,000)
$ (950,000)
Cost of goods sold
820,000
500,000
Depreciation expense
104,000
85,000
Amortization expense
220,000
120,000
Interest expense
20,000
15,000
Equity in earnings of Sander
(124,000)
–0–
Net Income
$ (700,000)
$ (230,000)
Retained earnings 1/1/11
$(2,800,000)
$ (345,000)
Net Income
(700,000)
(230,000)
Dividends paid
200,000
25,000
Retained earnings 12/31/11
$(3,300,000)
$ (550,000)
Cash
$ 535,000
$ 115,000
Accounts receivable
575,000
215,000
Inventory
990,000
800,000
Investment in Sander
1,420,000
–0–
Buildings and equipment
1,025,000
863,000
Patents
950,000
107,000
Total assets
$ 5,495,000
$ 2,100,000
Accounts payable
$ (450,000)
$ (200,000)
Notes payable
(545,000)
(450,000)
Common stock
(900,000)
(800,000)
Additional paid in capital
(300,000)
(100,000)
Retained earnings 12/31/11
(3,300,000)
(550,000)
Total liabilities and stockholders’ equity
$(5,495,000)
$(2,100,000)
a. Prepare a schedule that calculates the Equity in Earnings of Sander account balance.
b. Prepare a worksheet to arrive at consolidated figures for external reporting purposes.
On January 1, 2009, Monica Company acquired 70 percent of Young Company’s outstanding common stock for $665,000. The fair value of the noncontrolling interest at the acquisition date was $285,000.
Young reported stockholders’ equity accounts on that date as follows:
Common stock—$10 par value
$300,000
Additional paid in capital
90,000
Retained earnings
410,000
In establishing the acquisition value, Monica appraised Young’s assets and ascertained that the accounting records undervalued a building (with a five year life) by $50,000. Any remaining excess acquisition date fair value was allocated to a franchise agreement to be amortized over 10 years. During the subsequent years, Young sold Monica inventory at a 30 percent gross profit rate. Monica consistently resold this merchandise in the year of acquisition or in the period immediately following. Transfers for the three years after this business combination was created amounted to the following:
Year
Transfer Price
Inventory Remaining
at Year End (at transfer price)
2009
$60,000
$10,000
2010
80,000
12,000
2011
90,000
18,000
In addition, Monica sold Young several pieces of fully depreciated equipment on January 1, 2010, for $36,000. The equipment had originally cost Monica $50,000. Young plans to depreciate these assets over a six year period.
In 2011, Young earns a net income of $160,000 and distributes $50,000 in cash dividends. These figures increase the subsidiary’s Retained Earnings to a $740,000 balance at the end of 2011. During this same year, Monica reported dividend income of $35,000 and an investment account containing the initial value balance of $665,000.
Prepare the 2011 consolidation worksheet entries for Monica and Young. In addition, compute the noncontrolling interest’s share of the subsidiary’s net income for 2011.
On January 1, 2010, Parkway, Inc., issued securities with a total fair value of $450,000 for 100 percent of Skyline Corporation’s outstanding ownership shares. Skyline has long supplied inventory to Parkway, which hopes to achieve synergies with production scheduling and product development with this combination.
Although Skyline’s book value at the acquisition date was $300,000, the fair value of its trademarks was assessed to be $30,000 more than their carrying values. Additionally, Skyline’s patented technology was undervalued in its accounting records by $120,000. The trademarks were considered to have indefinite lives, the estimated remaining life of the patented technology was eight years. In 2010, Skyline sold Parkway inventory costing $30,000 for $50,000. As of December 31, 2010, Parkway had resold only 28 percent of this inventory. In 2011, Parkway bought from Skyline $80,000 of inventory that had an original cost of $40,000. At the end of 2011, Parkway held $28,000 of inventory acquired from Skyline, all from its 2011 purchases.
During 2011, Parkway sold Skyline a parcel of land for $95,000 and recorded a gain of $18,000 on the sale. Skyline still owes Parkway $65,000 related to the land sale.
At the end of 2011, Parkway and Skyline prepared the following statements in preparation for consolidation.
Parkway, Inc
Skyline Corporation
Revenues
$ (627,000)
$(358,000)
Cost of goods sold
289,000
195,000
Other operating expenses
170,000
75,000
Gain on sale of land
(18,000)
–0–
Equity in Skyline’s earnings
(55,400)
–0–
Net income
$ (241,400)
$ (88,000)
Retained earnings 1/1/11
$ (314,600)
$(292,000)
Net income
(241,400)
(88,000)
Dividends distributed
70,000
20,000
Retained earnings 12/31/11
$ (486,000)
$(360,000)
Cash and receivables
$ 134,000
$ 150,000
Inventory
281,000
112,000
Investment in Skyline
598,000
–0–
Trademarks
–0–
50,000
Land, buildings, and equip (net)
637,000
283,000
Patented technology
–0–
130,000
Total assets
$ 1,650,000
$ 725,000
Liabilities
$ (463,000)
$(215,000)
Common stock
(410,000)
(120,000)
Additional paid in capital
(291,000)
(30,000)
Retained earnings 12/31/11
(486,000)
(360,000)
Total liabilities and equity
$(1,650,000)
$(725,000)
a. Show how Parkway computed its $55,400 equity in Skyline’s earnings balance.
b. Prepare a 2011 consolidated worksheet for Parkway and Skyline.
On January 1, 2010, Patrick Company purchased 100 percent of the outstanding voting stock of Shawn, Inc., for $1,000,000 in cash and other consideration. At the purchase date, Shawn had common stock of $500,000 and retained earnings of $185,000. Patrick attributed the excess of acquisition date fair value over Shawn’s book value to a trade name with a 25 year life. Patrick uses the equity method to account
for its investment in Shawn.
During the next two years, Shawn reported the following:
Income
Dividends
Inventory Transfers to Patrick at Transfer Price
2010
$78,000
$25,000
$190,000
2011
85,000
27,000
210,000
Shawn sells inventory to Patrick after a markup based on a gross profit rate. At the end of 2010 and 2011, 30 percent of the current year purchases remain in Patrick’s inventory.
Required
Create an Excel spreadsheet that computes the following:
1. Equity method balance in Patrick’s Investment in Shawn, Inc., account as of December 31, 2011.
2. Worksheet adjustments for the December 31, 2011, consolidation of Patrick and Shawn.
Formulate your solution so that Shawn’s gross profit rate on sales to Patrick is treated as a variable.
Granger Eagles Players’ Association and Mr. Doublecount, the CEO of Granger Eagles Baseball Company, ask your help in resolving a salary dispute. Mr. Doublecount presents the following income statement to the player representatives.
GRANGER EAGLES BASEBALL COMPANY INCOME STATEMENT
Ticket revenues
$2,000,000
Stadium rent expense
$1,400,000
Ticket expense
25,000
Promotion
35,000
Player salaries
400,000
Staff salaries and miscellaneous
200,000
2,060,000
Net income (loss)
$ (60,000)
Mr. Doublecount argues that the Granger Eagles really lose money and, until things turn around, a salary increase is out of the question.
As a result of your inquiry, you discover that Granger Eagles Baseball Company owns 91 percent of the voting stock in Eagle Stadium, Inc. This venue is specifically designed for baseball and is where the Eagles play their entire home game schedule. However, Mr. Doublecount does not wish to consider the profits of Eagle Stadium in the negotiations with the players. He claims that “the stadium is really a separate business entity that was purchased separately from the team” and therefore does not concern the players. The Eagles Stadium income statement appears as follows:
EAGLES STADIUM, INC INCOME STATEMENT
Stadium rent revenue
$1,400,000
Concession revenue
800,000
Parking revenue
100,000
$2,300,000
Cost of goods sold
250,000
Depreciation
80,000
Staff salaries and miscellaneous
150,000
480,000
Net income (loss)
$1,820,000
Required
1. What advice would you provide the negotiating parties regarding the issue of considering the Eagles Stadium income statement in their discussions? What authoritative literature could you cite in supporting your advice?
2. What other pertinent information would you need to provide a specific recommendation regarding players’ salaries?
Pop, Inc., acquires 90 percent of the 20,000 shares of Son Company’s outstanding common stock on December 31, 2009. Of the acquisition date fair value, it allocates $80,000 to covenants, a figure amortized at the rate of $2,000 per year. Comparative consolidated balance sheets for 2011 and 2010 are as follow:
2011
2010
Cash
$ 210,000
$ 130,000
Accounts receivable
350,000
220,000
Inventory
320,000
278,000
Land, buildings, and equipment (net)
1,090,000
1,120,000
Covenants
78,000
80,000
Total assets
$2,048,000
$1,828,000
Accounts payable
$ 290,000
$ 296,000
Long term liabilities
650,000
550,000
Noncontrolling interest
37,800
34,000
Preferred stock (10% cumulative)
100,000
100,000
Common stock (26,000 shares outstanding)
520,000
520,000
Retained earnings, 12/31
450,200
328,000
Total liabilities and stockholders’ equity
$2,048,000
$1,828,000
Additional Information for 2011
• Consolidated net income (after adjustments for all intra entity items) was $178,000.
• Consolidated depreciation and amortization equaled $52,000.
• On April 10, Son sold a building with a $40,000 book value, receiving cash of $50,000. Later that month, Pop borrowed $100,000 from a local bank and purchased equipment for $60,000. These transactions were all with outside parties.
• During the year, Pop paid $40,000 dividends on its common stock and $10,000 on its preferred stock, and Son paid a $20,000 dividend on its common stock.
• Son has long term convertible debt of $180,000 outstanding included in consolidated liabilities. It recognized interest expense of $16,000 (net of taxes) on this debt during the year. This debt can be exchanged for 10,000 shares of the subsidiary’s common stock. Pop owns none of this debt.
• Son recorded $60,000 net income from its own operations. Noncontrolling interest in Son’s income was $5,800.
• Pop recorded $4,000 in profits on sales of goods to Son. These goods remain in Son’s warehouse at December 31.
• Pop applies the equity method to account for its investment in Son. On its own books, Pop recognized $48,200 equity in earnings from Son (90% X[$60,000 less $2,000 amortization] and $4,000 unrealized intra entity profit on its sales to Son).
Required
a. Prepare a consolidated statement of cash flows for Pop, Inc., and Son Company for the year ending December 31, 2011. Use the indirect approach for determining the amount of cash generated by normal operations.11
b. Compute basic earnings per share and diluted earnings per share for Pop. Inc.
A subsidiary has a debt outstanding that was originally issued at a discount. At the beginning of the current year, the parent company acquired the debt at a slight premium from outside parties. Which of the following statements is true?
a. Whether the balances agree or not, both the subsequent interest income and interest expense should be reported in a consolidated income statement.
b. The interest income and interest expense will agree in amount and should be offset for consolidation purposes.
c. In computing any noncontrolling interest allocation, the interest income should be included but not the interest expense.
d. Although subsequent interest income and interest expense will not agree in amount, both balances should be eliminated for consolidation purposes.
Warrenton, Inc., owns 80 percent of Aminable Corporation. On a consolidated income statement, the Noncontrolling Interest in the Subsidiary’s Income is reported as $37,000. Aminable paid a total cash dividend of $100,000 for the year. How does this impact the consolidated statement of cash flows?
a. The dividends paid to the outside owners are reported as a financing activity, but the noncontrolling interest figure is not viewed as a cash flow.
b. The noncontrolling interest figure is reported as an investing activity, but the dividends amount paid to the outside owners is omitted entirely.
c. Neither figure is reported on the statement of cash flows.
d. Both dividends paid and the noncontrolling interest are viewed as financing activities.
On January 1, 2011, Morey, Inc., exchanged $178,000 for 25 percent of Amsterdam Corporation. Morey appropriately applied the equity method to this investment. At January 1, the book values of Amsterdam’s assets and liabilities approximated their fair values.
On June 30, 2011, Morey paid $560,000 for an additional 70 percent of Amsterdam, thus increasing its overall ownership to 95 percent. The price paid for the 70 percent acquisition was proportionate to Amsterdam’s total fair value. At June 30, the carrying values of Amsterdam’s assets and liabilities approximated their fair values. Any remaining excess fair value was attributed to goodwill. Amsterdam reports the following amounts at December 31, 2011 (credit balances shown in parentheses):
Revenues
($210,000)
Expenses
140,000
Retained earnings, January 1
200,000
Dividends, October 1
20,000
Common stock
500,000
Amsterdam’s revenue and expenses were distributed evenly throughout the year and no changes in Amsterdam’s stock have occurred. Using the acquisition method, compute the following:
a. The acquisition date fair value of Amsterdam to be included in Morey’s consolidated financial statements.
b. The revaluation gain (or loss) reported by Morey for its 25 percent investment in Amsterdam on June 30.
c. The amount of goodwill recognized by Morey on its December 31 balance sheet (assume no impairments have been recognized).
d. The noncontrolling interest amount reported by Morey on its
Posada Company acquired 7,000 of the 10,000 outstanding shares of Sabathia Company on January 1, 2010, for $840,000. The subsidiary’s total fair value was assessed at $1,200,000 although its book value on that date was $1,130,000. The $70,000 fair value in excess of Sabathia’s book value was assigned to a patent with a 5 year remaining life.
On January 1, 2012, Posada reported a $1,085,000 equity method balance in the Investment in Sabathia Company account. On October 1, 2012, Posada sells 1,000 shares of the investment for $191,000. During 2012, Sabathia reported net income of $120,000 and paid dividends of $40,000. These amounts are assumed to have occurred evenly throughout the year.
a. How should Posada report the 2012 income that accrued to the 1,000 shares prior to their sale? b. What is the effect on Posada’s financial statements from this sale of 1,000 shares?
c. How should Posada report in its financial statements the 6,000 shares of Sabathia it continues to hold?
On January 1, 2009, Telconnect acquires 70 percent of Bandmor for $490,000 cash. The remaining 30 percent of Bandmor’s shares continued to trade at a total value of $210,000. The new subsidiary reported common stock of $300,000 on that date, with retained earnings of $180,000. A patent was undervalued in the company’s financial records by $30,000. This patent had a 5 year remaining life. Goodwill of $190,000 was recognized and allocated proportionately to the controlling and noncontrolling interests. Bandmor earns income and pays cash dividends as follows:
Year
Net Income
Dividends Paid
2009
$75,000
$39,000
2010
96,000
44,000
2011
110,000
60,000
On December 31, 2011, Telconnect owes $22,000 to Bandmor.
a. If Telconnect has applied the equity method, what consolidation entries are needed as of December 31, 2011?
b. If Telconnect has applied the initial value method, what Entry *C is needed for a 2011 consolidation?
c. If Telconnect has applied the partial equity method, what Entry *C is needed for a 2011 consolidation?
d. What noncontrolling interest balances will appear in consolidated financial statements for 2011?
Miller Company acquired an 80 percent interest in Taylor Company on January 1, 2009. Miller paid $664,000 in cash to the owners of Taylor to acquire these shares. In addition, the remaining 20 percent of Taylor shares continued to trade at a total value of $166,000 both before and after Miller’s acquisition. On January 1, 2009, Taylor reported a book value of $600,000 (Common Stock =$300,000; Additional Paid In Capital =$90,000; Retained Earnings = $210,000). Several of Taylor’s buildings that had a remaining life of 20 years were undervalued by a total of $80,000. During the next three years, Taylor reported the following figures:
Year
Net Income
Dividends Paid
2009
$70,000
$10,000
2010
90,000
15,000
2011
100,000
20,000
Determine the appropriate answers for each of the following questions:
a. What amount of excess depreciation expense should be recognized in the consolidated financial statements for the initial years following this acquisition?
b. If a consolidated balance sheet is prepared as of January 1, 2009, what amount of goodwill should be recognized?
c. If a consolidation worksheet is prepared as of January 1, 2009, what Entry S and Entry A should be included?
d. On the separate financial records of the parent company, what amount of investment income would be reported for 2009 under each of the following accounting methods?
(1) The equity method.
(2) The partial equity method.
(3) The initial value method.
e. On the parent company’s separate financial records, what would be the December 31, 2011, balance for the Investment in Taylor Company account under each of the following accounting methods?
(4) The equity method.
(5) The partial equity method.
(6) The initial value method.
f. As of December 31, 2010, Miller’s Buildings account on its separate records has a balance of $800,000 and Taylor has a similar account with a $300,000 balance. What is the consolidated balance for the Buildings account?
g. What is the balance of consolidated goodwill as of December 31, 2011?
h. Assume that the parent company has been applying the equity method to this investment. On
December 31, 2011, the separate financial statements for the two companies present the following information:
Miller Company
Taylor Company
Common stock
$500,000
$300,000
Additional paid in capital .
280,000
90,000
Retained earnings, 12/31/11
620,000
425,000
What will be the consolidated balance of each of these accounts?
Following are several account balances taken from the records of Karson and Reilly as of December 31, 2011. A few asset accounts have been omitted here. All revenues, expenses, and dividends occurred evenly throughout the year. Annual tests have indicated no goodwill impairment.
Karson
Reilly
Sales
$ (800,000)
$(500,000)
Cost of goods sold
400,000
280,000
Operating expenses
200,000
100,000
Investment income
not given
–0–
Retained earnings, 1/1
(1,400,000)
(700,000)
Dividends
80,000
20,000
Trademarks
600,000
200,000
Royalty agreements
700,000
300,000
Licensing agreements
400,000
400,000
Liabilities
(500,000)
(200,000)
Common stock ($10 par value)
(400,000)
(100,000)
Additional paid in capital
(500,000)
(600,000)
On July 1, 2011, Karson acquired 80 percent of Reilly for $1,330,000 cash consideration. In addition, Karson agreed to pay additional cash to the former owners of Reilly if certain performance measures are achieved after three years. Karson assessed a $30,000 fair value for the contingent performance obligation as of the acquisition date and as of December 31, 2011. On July 1, 2011, Reilly’s assets and liabilities had book values equal to their fair value except for some trademarks (with 5 year remaining lives) that were undervalued by $150,000. Karson estimated Reilly’s total fair value at $1,700,000 on July 1, 2011.
For a consolidation prepared at December 31, 2011, what balances would be reported for the following?
Nascent, Inc., acquires 60 percent of Sea Breeze Corporation for $414,000 cash on January 1, 2009. The remaining 40 percent of the Sea Breeze shares traded near a total value of $276,000 both before and after the acquisition date. On January 1, 2009, Sea Breeze had the following assets and liabilities:
Book Value
Fair Value
Current assets
$150,000
$150,000
Land
200,000
200,000
Buildings (net) (6 year life)
300,000
360,000
Equipment (net) (4 year life)
300,000
280,000
Patent (10 year life)
–0–
100,000
Liabilities
(400,000)
(400,000)
The companies’ financial statements for the year ending December 31, 2012, follow:
Nascent
Sea Breeze
Revenues
$ (600,000)
$ (300,000)
Operating expenses
410,000
210,000
Investment income
(42,000)
–0–
Net income
$ (232,000)
$ (90,000)
Retained earnings, 1/1/12
$ (700,000)
$ (300,000)
Net income
(232,000)
(90,000)
Dividends paid
92,000
70,000
Retained earnings, 12/31/12
$ (840,000)
$ (320,000)
Current assets
$ 330,000
$ 100,000
Land
220,000
200,000
Buildings (net)
700,000
200,000
Equipment (net)
400,000
500,000
Investment in Sea Breeze
414,000
–0–
Total assets
$ 2,064,000
$ 1,000,000
Liabilities
$ (500,000)
$ (200,000)
Common stock
(724,000)
(480,000)
Retained earnings, 12/31/12
(840,000)
(320,000)
Total liabilities and equities
$(2,064,000)
$(1,000,000)
Answer the following questions:
a. How can the accountant determine that the parent has applied the initial value method?
b. What is the annual excess amortization initially recognized in connection with this acquisition?
c. If the parent had applied the equity method, what investment income would the parent have recorded in 2012?
d. What is the parent’s portion of consolidated retained earnings as of January 1, 2012?
e. What is consolidated net income for 2012 and what amounts are attributable to the controlling and noncontrolling interests?
f. Within consolidated statements at January 1, 2009, what balance is included for the subsidiary’s Buildings account?
g. What is the consolidated Buildings reported balance as of December 31, 2012?
On January 1, 2010, Pierson Corporation exchanged $1,710,000 cash for 90 percent of the outstanding voting stock of Steele Company. The consideration transferred by Pierson provided a reasonable basis for assessing the total January 1, 2010, fair value of Steele Company. At the acquisition date, Steele reported the following owner’s equity amounts in its balance sheet:
Common stock
$400,000
Additional paid in capital
60,000
Retained earnings
265,000
In determining its acquisition offer, Pierson noted that the values for Steele’s recorded assets and liabilities approximated their fair values. Pierson also observed that Steele had developed internally a customer base with an assessed fair value of $800,000 that was not reflected on Steele’s books. Pierson expected both cost and revenue synergies from the combination.
At the acquisition date, Pierson prepared the following fair value allocation schedule:
Fair value of Steele Company
$1,900,000
Book value of Steele Company
725,000
Excess fair value
1,175,000
to customer base (10 year remaining life)
800,000
to goodwill
$ 375,000
At December 31, 2011, the two companies report the following balances:
Pierson
Steele
Revenues
(1,843,000)
(675,000)
Cost of goods sold
1,100,000
322,000
Depreciation expense
125,000
120,000
Amortization expense
275,000
11,000
Interest expense
27,500
7,000
Equity in income of Steele
(121,500)
Net income
(437,000)
(215,000)
Retained earnings, 1/1
(2,625,000)
(395,000)
Net income
(437,000)
(215,000)
Dividends paid
350,000
25,000
Retained earnings, 12/31
(2,712,000)
(585,000)
Current assets
1,204,000
430,000
Investment in Steele
1,854,000
Buildings and equipment
931,000
863,000
Copyrights
950,000
107,000
Total assets
4,939,000
1,400,000
Accounts payable
(485,000)
(200,000)
Notes payable
(542,000)
(155,000)
Common stock
(900,000)
(400,000)
Additional paid in capital
(300,000)
(60,000)
Retained earnings, 12/31
(2,712,000)
(585,000)
Total liabilities and equities
(4,939,000)
(1,400,000)
a. Using the acquisition method, determine the consolidated balances for this business combination as of December 31, 2011.
b. If instead the noncontrolling interest’s acquisition date fair value is assessed at $152,500, what changes would be evident in the consolidated statements?
The Krause Corporation acquired 80 percent of the 100,000 outstanding voting shares of Leahy, Inc., for $6.30 per share on January 1, 2011. The remaining 20 percent of Leahy’s shares also traded actively at $6.30 per share before and after Krause’s acquisition. An appraisal made on that date determined that all book values appropriately reflected the fair values of Leahy’s underlying accounts except that a building with a 5 year life was undervalued by $45,000 and a fully amortized trademark with an estimated 10 year remaining life had a $60,000 fair value. At the acquisition date, Leahy reported common stock of $100,000 and a retained earnings balance of $280,000. Following are the separate financial statements for the year ending December 31, 2012:
Krause Corporation
Leahy, Inc
Sales
$ (584,000)
$(250,000)
Cost of goods sold
194,000
95,000
Operating expenses
246,000
65,000
Dividend income
(16,000)
–0–
Net income
$ (160,000)
$ (90,000)
Retained earnings, 1/1/12
$ (700,000)
$(350,000)
Net income (above)
(160,000)
(90,000)
Dividends paid
70,000
20,000
Retained earnings, 12/31/12
$ (790,000)
$(420,000)
Current assets
$ 296,000
$ 191,000
Investment in Leahy, Inc
504,000
–0–
Buildings and equipment (net)
680,000
390,000
Trademarks
100,000
144,000
Total assets
$ 1,580,000
$ 725,000
Liabilities
$ (470,000)
$(205,000)
Common stock
(320,000)
(100,000)
Retained earnings, 12/31/12 (above)
(790,000)
(420,000)
Total liabilities and equities
$(1,580,000)
$(725,000)
a. Prepare a worksheet to consolidate these two companies as of December 31, 2012.
b. Prepare a 2012 consolidated income statement for Krause and Leahy.
c. If instead the noncontrolling interest shares of Leahy had traded for $4.85 surrounding Krause’s acquisition date, how would the consolidated statements change?
32. Father, Inc., buys 80 percent of the outstanding common stock of Sam Corporation on January 1, 2011, for $680,000 cash. At the acquisition date, Sam’s total fair value was assessed at $850,000 although Sam’s book value was only $600,000. Also, several individual items on Sam’s financial records had fair values that differed from their book values as follows:
Book Value
Fair Value
Land
$ 60,000
$ 225,000
Buildings and equipment (10 year remaining life)
275,000
250,000
Copyright (20 year life)
100,000
200,000
Notes payable (due in 8 years)
(130,000)
(120,000)
For internal reporting purposes, Father, Inc., employs the equity method to account for this investment. The following account balances are for the year ending December 31, 2011, for both companies. Using the acquisition method, determine consolidated balances for this business combination (through either individual computations or the use of a worksheet).
Adams Corporation acquired 90 percent of the outstanding voting shares of Barstow, Inc., on December 31, 2009. Adams paid a total of $603,000 in cash for these shares. The 10 percent noncontrolling interest shares traded on a daily basis at fair value of $67,000 both before and after Adams’s acquisition. On December 31, 2009, Barstow had the following account balances:
Book Value
Fair Value
Current assets
$ 160,000
$ 160,000
Land
120,000
150,000
Buildings (10 year life)
220,000
200,000
Equipment (5 year life)
160,000
200,000
Patents (10 year life)
–0–
50,000
Notes payable (5 year life)
(200,000)
(180,000)
Common stock
(180,000)
Retained earnings, 12/31/09
(280,000)
December 31, 2011, adjusted trial balances for the two companies follow:
Debits
Adams Corporation
Barstow, Inc
Current assets
$ 610,000
$ 250,000
Land
380,000
150,000
Buildings
490,000
250,000
Equipment
873,000
150,000
Investment in Barstow, Inc
702,000
–0–
Cost of goods sold
480,000
90,000
Depreciation expense
100,000
55,000
Interest expense
40,000
15,000
Dividends paid
110,000
70,000
Total debits
$3,785,000
$1,030,000
Credits
Notes payable
$ 860,000
$ 230,000
Common stock
510,000
180,000
Retained earnings, 1/1/11
1,367,000
340,000
Revenues
940,000
280,000
Investment income
108,000
–0–
Total credits
$3,785,000
$1,030,000
a. Prepare schedules for acquisition date fair value allocations and amortizations for Adams’s investment in Barstow.
b. Determine Adams’s method of accounting for its investment in Barstow. Support your answer with a numerical explanation.
c. Without using a worksheet or consolidation entries, determine the balances to be reported as of December 31, 2011, for this business combination.
d. To verify the figures determined in requirement (c), prepare a consolidation worksheet for Adams Corporation and Barstow, Inc., as of December 31, 2011.
Following are the individual financial statements for Gibson and Davis for the year ending December 31, 2011:
Gibson
Davis
Sales
$ (600,000)
$ (300,000)
Cost of goods sold
300,000
140,000
Operating expenses
174,000
60,000
Dividend income
(24,000)
–0–
Net income
$ (150,000)
$ (100,000)
Retained earnings, 1/1/11
$ (700,000)
$ (400,000)
Net income
(150,000)
(100,000)
Dividends paid
80,000
40,000
Retained earnings, 12/31/11
$ (770,000)
$ (460,000)
Cash and receivables
$ 248,000
$ 100,000
Inventory
500,000
190,000
Investment in Davis
528,000
–0–
Buildings (net)
524,000
600,000
Equipment (net)
400,000
400,000
Total assets
$ 2,200,000
$ 1,290,000
Liabilities
(800,000)
(490,000)
Common stock
(630,000)
(340,000)
Retained earnings, 12/31/11
(770,000)
(460,000)
Total liabilities and stockholders’ equity
$(2,200,000)
$(1,290,000)
Gibson acquired 60 percent of Davis on April 1, 2011, for $528,000. On that date, equipment owned by Davis (with a five year remaining life) was overvalued by $30,000. Also on that date, the fair value of the 40 percent noncontrolling interest was $352,000. Davis earned income evenly during the year but paid the entire dividend on November 1, 2011.
a. Prepare a consolidated income statement for the year ending December 31, 2011.
b. Determine the consolidated balance for each of the following accounts as of December 31, 2011:
On January 1, 2011, Allan Company bought a 15 percent interest in Sysinger Company. The acquisition price of $184,500 reflected an assessment that all of Sysinger’s accounts were fairly valued within the company’s accounting records. During 2011, Sysinger reported net income of $100,000 and paid cash dividends of $30,000. Allan possessed the ability to influence significantly Sysinger’s operations and, therefore, accounted for this investment using the equity method.
On January 1, 2012, Allan acquired an additional 80 percent interest in Sysinger and provided the following fair value assessments of Sysinger’s ownership components:
Consideration transferred by Allan for 80% interest
$1,400,000
Fair value of Allan’s 15% previous ownership
262,500
Noncontrolling interest’s 5% fair value
87,500
Total acquisition date fair value for Sysinger Company
$1,750,000
Also, as of January 1, 2012, Allan assessed a $400,000 value to an unrecorded customer contract recently negotiated by Sysinger. The customer contract is anticipated to have a remaining life of 4 years. Sysinger’s other assets and liabilities were judged to have fair values equal to their book values. Allan elects to continue applying the equity method to this investment for internal reporting purposes.
At December 31, 2012, the following financial information is available for consolidation:
Allan Company
Sysinger Company
Revenues
$ (931,000)
$ (380,000)
Operating expenses
615,000
230,000
Equity earnings of Sysinger
(47,500)
–0–
Gain on revaluation of Investment in Sysinger
to fair value
(67,500)
–0–
Net income
$ 431,000
$ 150,000
Retained earnings, January 1
$ (965,000)
$ (600,000)
Net income (above)
(431,000)
(150,000)
Cash dividends paid to stockholders
140,000
40,000
Retained earnings, December 31
$ (1,256,000)
$ (710,000)
Current assets
$ 288,000
$ 540,000
Investment in Sysinger (equity method)
1,672,000
–0–
Property, plant, and equipment
826,000
590,000
Patented technology
850,000
370,000
Customer contract
–0–
–0–
Total assets
$ 3,636,000
$ 1,500,000
Liabilities
$ (1,300,000)
$ (90,000)
Common stock
(900,000)
(500,000)
Additional paid in capital
(180,000)
(200,000)
Retained earnings, December 31
(1,256,000)
(710,000)
Total liabilities and equities
$ (3,636,000)
$(1,500,000)
a. How should Allan allocate Sysinger’s total acquisition date fair value (January 1, 2012) to the assets acquired and liabilities assumed for consolidation purposes?
b. Show how the following amounts on Allan’s pre consolidation 2012 statements were derived:
• Equity in earnings of Sysinger.
• Gain on revaluation of Investment in Sysinger to fair value.
• Investment in Sysinger.
c. Prepare a worksheet to consolidate the financial statements of these two companies as of December 31, 2012.
On January 1, 2010, Bretz, Inc., acquired 60 percent of the outstanding shares of Keane Company for $573,000 in cash. The price paid was proportionate to Keane’s total fair value although at the date of acquisition, Keane had a total book value of $810,000. All assets acquired and liabilities assumed had fair values equal to book values except for a copyright (six year remaining life) that was undervalued in Keane’s accounting records by $120,000. During 2010, Keane reported net income of $150,000 and paid cash dividends of $80,000. On January 1, 2011, Bretz bought an additional 30 percent interest in Keane for $300,000.
The following financial information is for these two companies for 2011. Keane issued no additional capital stock during either 2010 or 2011.
Bretz, Inc.
Keane Company
Revenues
$ (402,000)
$ (300,000)
Operating expenses
200,000
120,000
Equity in Keane earnings
(144,000)
–0–
Net income
$ (346,000)
$ (180,000)
Retained earnings 1/1
$ (797,000)
$ (500,000)
Net income (above)
(346,000)
(180,000)
Dividends paid
143,000
60,000
Retained earnings 12/31
$(1,000,000)
$ (620,000)
Current assets
$ 224,000
$ 190,000
Investment in Keane Company
994,500
–0–
Trademarks
106,000
600,000
Copyrights
210,000
300,000
Equipment (net)
380,000
110,000
Total assets
$ 1,914,500
$ 1,200,000
Liabilities
$ (453,000)
$ (200,000)
Common stock
(400,000)
(300,000)
Additional paid in capital
(60,000)
(80,000)
Additional paid in capital—step acquisition
(1,500)
–0–
Retained earnings 12/31
(1,000,000)
(620,000)
Total liabilities and equities
$(1,914,500)
$(1,200,000)
a. Show the journal entry Bretz made to record its January 1, 2011, acquisition of an additional 30 percent of Keane Company shares.
b. Prepare a schedule showing how Bretz determined the Investment in Keane Company balance as of December 31, 2011.
c. Prepare a consolidated worksheet for Bretz, Inc., and Keane Company for December 31, 2011.
Bon Air, Inc., purchased 70 percent (2,800 shares) of the outstanding voting stock of Creedmoor Corporation on January 1, 2007, for $250,000 cash. Creedmoor’s net assets on that date totaled $230,000, but this balance included three accounts having fair values that differed from their book values:
Book Value
Fair Value
Land
$ 30,000
$ 40,000
Equipment (14 year life)
50,000
118,000
Liabilities (10 year life)
(70,000)
(50,000)
As of December 31, 2010, the two companies report the following balances:
Bon Air
Creedmoor
Revenues
$ (694,800)
$(250,000)
Operating expenses
630,000
180,000
Investment income
(44,200)
–0–
Net income
$ (109,000)
$ (70,000)
Retained earnings, 1/1/10
$ (760,000)
$(260,000)
Net income
(109,000)
(70,000)
Dividends paid
68,000
10,000
Retained earnings, 12/31/10
$ (801,000)
$(320,000)
Current assets
$ 72,000
$ 120,000
Investment in Creedmoor Corp
321,800
–0–
Land
241,000
50,000
Buildings (net)
289,000
200,000
Equipment (net)
165,200
40,000
Total assets
$ 1,089,000
$ 410,000
Liabilities
$ (180,000)
$ (50,000)
Common stock
(50,000)
(40,000)
Additional paid in capital
(58,000)
–0–
Retained earnings, 12/31/10
(801,000)
(320,000)
Total liabilities and equities
$(1,089,000)
$(410,000)
Prepare a worksheet to consolidate these two companies as of December 31, 2010. Because Bon Air acquired Creedmoor before the effective date of the acquisition method (2009), the purchase method is appropriate.
Watson, Inc., purchased 60 percent of Houston, Inc., on January 1, 2008, for $400,000 in cash. On that date, assets and liabilities of the subsidiary had the following values:
Book Value
Fair Value
Current assets
$ 320,000
$ 320,000
Equipment (net) (10 year life)
410,000
380,000
Buildings (net) (15 year life)
300,000
455,000
Current liabilities
(190,000)
(190,000)
Bonds payable (due in 10 years)
(370,000)
(350,000)
On December 31, 2011, these two companies report the following figures:
Watson
Houston
Revenues
$ (640,000)
$ (280,000)
Operating expenses
480,000
210,000
Equity in subsidiary earnings
(36,400)
–0–
Net income
$ (196,400)
$ (70,000)
Retained earnings, 1/1/11
$ (683,400)
$ (380,000)
Net income
(196,400)
(70,000)
Dividends paid
60,200
40,000
Retained earnings, 12/31/11
$ (819,600)
$ (410,000)
Current assets
$ 215,000
$ 260,000
Investment in Houston
491,600
–0–
Equipment (net)
500,000
420,000
Buildings (net)
413,000
520,000
Total assets
$ 1,619,600
$ 1,200,000
Current liabilities
$ (390,000)
$ (170,000)
Bonds payable
(100,000)
(370,000)
Common stock
(310,000)
(250,000)
Retained earnings, 12/31/11
(819,600)
(410,000)
Total liabilities and equities
$(1,619,600)
$(1,200,000)
Answer each of the following questions using the purchase method:
a. The parent shows a $36,400 balance as its Equity in Subsidiary Earnings. How was this balance calculated?
b. Is an adjustment to the parent’s Retained Earnings as of January 1, 2011, needed? Why or why not?
c. How much total amortization expense should be recognized for consolidation purposes in 2011?
d. What is the noncontrolling interest in the subsidiary’s net income?
e. Prepare a consolidated income statement.
f. What allocations were made as a result of the purchase price? What amount of each allocation remains at the end of 2011?
g. What is the December 31, 2011, amount in Noncontrolling Interest in the Subsidiary? What three components make up this total?
h. Prepare a consolidated balance sheet as of December 31, 2011.
Good Corporation acquired 80 percent of the outstanding stock of Morning, Inc., on January 1, 2008, for $1,400,000 in cash, debt, and stock. One of Morning’s buildings, with a 10 year remaining life, was undervalued on the company’s accounting records by $80,000. Also, Morning’s newly developed unpatented technology, with an estimated 10 year life, was assessed to have a fair value of $550,000. During subsequent years, Morning reports the following:
Net Income
Dividends Paid
2008
$180,000
$100,000
2009
200,000
100,000
2010
300,000
100,000
2011
400,000
120,000
The following trial balances are for these two companies as of December 31, 2011. Morning owes Good $100,000 as of this date.
Good
Morning
Debits
Cash
$ 300,000
$ 200,000
Receivables
700,000
400,000
Inventory
400,000
500,000
Investment in Morning
1,400,000
–0–
Land
700,000
600,000
Buildings (net)
300,000
700,000
Operating expenses
400,000
100,000
Dividends paid
380,000
120,000
Total debits
$4,580,000
$2,620,000
Liabilities
$ 200,000
$ 620,000
Common stock
1,000,000
460,000
Additional paid in capital
600,000
40,000
Retained earnings, 1/1/11
1,800,000
1,000,000
Revenues
884,000
500,000
Dividend income
96,000
–0–
Total credits
$4,580,000
$2,620,000
Using the purchase method, prepare consolidated balances for this business combination for 2011.
On January 1, 2009, Daisy Company acquired 80 percent of Rose Company for $594,000 in cash. Rose’s total book value on that date was $610,000 and the fair value of the noncontrolling interest was $148,500. The newly acquired subsidiary possessed a trademark (10 year remaining life) that, although unrecorded on Rose’s accounting records, had a fair value of $75,000. Any remaining excess acquisition date fair value was attributed to goodwill.
Daisy decided to acquire Rose so that the subsidiary could furnish component parts for the parent’s production process. During the ensuing years, Rose sold inventory to Daisy as follows:
Year
Cost to Rose Company
Transfer Price
Gross Profit Rate
Transferred Inventory Still Held at End of Year (at transfer price)
2009
$100,000
$140,000
28.6%
$20,000
2010
100,000
150,000
33.3
30,000
2011
120,000
160,000
25.0
68,000
Any transferred merchandise that Daisy retained at a year end was always put into production during the following period.
On January 1, 2010, Daisy sold Rose several pieces of equipment that had a 10 year remaining life and were being depreciated on the straight line method with no salvage value. This equipment was transferred at an $80,000 price, although it had an original $100,000 cost to Daisy and a $44,000 book value at the date of exchange.
On January 1, 2011, Daisy sold land to Rose for $50,000, its fair value at that date. The original cost had been only $22,000. By the end of 2011, Rose had made no payment for the land.
The following separate financial statements are for Daisy and Rose as of December 31, 2011. Daisy has applied the equity method to account for this investment.
Daisy Company
Rose Company
Sales
$ (900,000)
$ (500,000)
Cost of goods sold
598,000
300,000
Operating expenses
210,000
80,000
Gain on sale of land
(28,000)
–0–
Income of Rose Company
(60,000)
–0–
Net income
$ (180,000)
$ (120,000)
Retained earnings, 1/1/11
$ (620,000)
$ (430,000)
Net income
(180,000)
(120,000)
Dividends paid
55,000
50,000
Retained earnings, 12/31/11
$ (745,000)
$ (500,000)
Cash and accounts receivable
$ 348,000
$ 410,000
Inventory
430,400
190,000
Investment in Rose Company
737,600
–0–
Land
454,000
280,000
Equipment
270,000
190,000
Accumulated depreciation
(180,000)
(50,000)
Total assets
$ 2,060,000
$ 1,020,000
Liabilities
(715,000)
(120,000)
Common stock
(600,000)
(400,000)
Retained earnings, 12/31/11
(745,000)
(500,000)
Total liabilities and equities
$(2,060,000)
$(1,020,000)
Required
Answer the following questions:
a. By how much did Rose’s book value increase during the period from January 1, 2009, through December 31, 2010?
b. During the initial years after the takeover, what annual amortization expense was recognized in connection with the acquisition date excess of fair value over book value?
c. What amount of unrealized gross profit exists within the parent’s inventory figures at the beginning and at the end of 2011?
d. Equipment has been transferred between the companies. What amount of additional depreciation is recognized in 2011 because of this transfer?
e. The parent reports Income of Rose Company of $60,000 for 2011. How was this figure calculated?
f. Without using a worksheet, determine consolidated totals.
g. Prepare the worksheet entries required at December 31, 2011, by the transfers of inventory, land, and equipment.
Dunn Corporation owns 100 percent of Grey Corporation’s common stock. On January 2, 2010, Dunn sold to Grey for $40,000 machinery with a carrying amount of $30,000. Grey is depreciating the acquired machinery over a five year life by the straight line method. The net adjustments to compute 2010 and 2011 consolidated net income would be an increase (decrease) of
Wallton Corporation owns 70 percent of the outstanding stock of Hastings, Incorporated. On January 1, 2009, Wallton acquired a building with a 10 year life for $300,000. Wallton anticipated no salvage value, and the building was to be depreciated on the straight line basis. On January 1, 2011, Wallton sold this building to Hastings for $280,000. At that time, the building had a remaining life of eight years but still no expected salvage value. In preparing financial statements for 2011, how does this transfer affect the computation of consolidated net income?
a. Income must be reduced by $32,000.
b. Income must be reduced by $35,000.
c. Income must be reduced by $36,000.
d. Income must be reduced by $40,000.
On January 1, Jarel acquired 80 percent of the outstanding voting stock of Suarez for $260,000 cash consideration. The remaining 20 percent of Suarez had an acquisition date fair value of $65,000. On January 1, Suarez possessed equipment (5 year life) that was undervalued on its books by $25,000. Suarez also had developed several secret formulas that Jarel assessed at $50,000. These formulas, although not recorded on Suarez’s financial records, were estimated to have a 20 year future life. As of December 31, the financial statements appeared as follows:
Jarel
Suarez
Revenues
$ (300,000)
$(200,000)
Cost of goods sold
140,000
80,000
Expenses
20,000
10,000
Net income
$ (140,000)
$(110,000)
Retained earnings, 1/1
$ (300,000)
$(150,000)
Net income
(140,000)
(110,000)
Dividends paid
–0–
–0–
Retained earnings, 12/31
$ (440,000)
$(260,000)
Cash and receivables
$ 210,000
$ 90,000
Inventory
150,000
110,000
Investment in Suarez
260,000
–0–
Equipment (net)
440,000
300,000
Total assets
$ 1,060,000
$ 500,000
Liabilities
$ (420,000)
$(140,000)
Common stock
(200,000)
(100,000)
Retained earnings, 12/31
(440,000)
(260,000)
Total liabilities and equities
$(1,060,000)
$(500,000)
During the year, Jarel bought inventory for $80,000 and sold it to Suarez for $100,000. Of these goods, Suarez still owns 60 percent on December 31.
Following are several figures reported for Preston and Sanchez as of December 31, 2011:
Preston
Sanchez
Inventory
$400,000
$200,000
Sales
800,000
600,000
Investment income
not given
Cost of goods sold
400,000
300,000
Operating expenses
180,000
250,000
Preston acquired 70 percent of Sanchez in January 2010. In allocating the newly acquired subsidiary’s fair value at the acquisition date, Preston noted that Sanchez having developed a customer list worth $65,000 unrecorded on its accounting records and having a five year remaining life. Any remaining excess fair value over Sanchez’s book value was attributed to goodwill. During 2011, Sanchez sells inventory costing $120,000 to Preston for $160,000. Of this amount, 20 percent remains unsold in Preston’s warehouse at year end. For Preston’s consolidated reports, determine the following amounts to be reported for the current year.
Inventory
Sales
Cost of Goods Sold
Operating Expenses
Noncontrolling Interest in the Subsidiary’s Net Income
On January 1, 2010, Corgan Company acquired 80 percent of the outstanding voting stock of Smashing, Inc., for a total of $980,000 in cash and other consideration. At the acquisition date, Smashing had common stock of $700,000, retained earnings of $250,000, and a noncontrolling interest fair value of $245,000. Corgan attributed the excess of fair value over Smashing’s book value to various covenants with a 20 year life. Corgan uses the equity method to account for its investment in Smashing. During the next two years, Smashing reported the following:
Net Income
Dividends
Inventory Purchases from Corgan
2010
$150,000
$35,000
$100,000
2011
130,000
45,000
120,000
Corgan sells inventory to Smashing using a 60 percent markup on cost. At the end of 2010 and 2011, 40 percent of the current year purchases remain in Smashing’s inventory.
a. Compute the equity method balance in Corgan’s Investment in Smashing, Inc., account as of December 31, 2011.
b. Prepare the worksheet adjustments for the December 31, 2011, consolidation of Corgan and Smashing.
(NOL Carryback and Carry forward, Valuation Account Needed) Nielson Inc. reports the following pretax income (loss) for both book and tax purposes. (Assume the carryback provision is used where possible for a net operating loss.)
Year
Pretax Income (Loss)
Tax Rate
2011
$100,000
40%
2012
90,000
40%
2013
(240,000)
45%
2014
120,000
45%
The tax rates listed were all enacted by the beginning of 2011.
Instructions
(a) Prepare the journal entries for the years 2011–2014 to record income tax expense (benefit), income taxes payable (refundable), and the tax effects of the loss carryback and loss carry forward, assuming that based on the weight of available evidence, it is more likely than not that one half of the benefits of the loss carry forward will not be realized.
(b) Prepare the income tax section of the 2013 income statement, beginning with the line “Operating loss before income taxes.”
(c) Prepare the income tax section of the 2014 income statement, beginning with the line “Income before income taxes.”
(NOL Carryback and Carry forward, Valuation Account Needed) Hayes Co. reported the following pretax financial income (loss) for the years 2011–2015.
2011
$240,000
2012
350,000
2013
90,000
2014
(550,000)
2015
180,000
Pretax financial income (loss) and taxable income (loss) were the same for all years involved. The enacted tax rate was 34% for 2011 and 2012, and 40% for 2013–2015. Assume the carryback provision is used first for net operating losses.
Instructions
(a) Prepare the journal entries for the years 2013–2015 to record income tax expense, income taxes payable (refundable), and the tax effects of the loss carryback and loss carry forward, assuming that based on the weight of available evidence, it is more likely than not that one fifth of the benefits of the loss carry forward will not be realized.
(b) Prepare the income tax section of the 2014 income statement, beginning with the line “Income (loss) before income taxes.”
(Three Differences, No Beginning Deferred Taxes, Multiple Rates) The following information is available for Remmers Corporation for 2012.
1. Depreciation reported on the tax return exceeded depreciation reported on the income statement by $120,000. This difference will reverse in equal amounts of $30,000 over the years 2013–2016.
2. Interest received on municipal bonds was $10,000.
3. Rent collected in advance on January 1, 2012, totaled $60,000 for a 3 year period. Of this amount, $40,000 was reported as unearned at December 31, 2012, for book purposes.
4. The tax rates are 40% for 2012 and 35% for 2013 and subsequent years.
5. Income taxes of $320,000 are due per the tax return for 2012.
6. No deferred taxes existed at the beginning of 2012.
Instructions
(a) Compute taxable income for 2012.
(b) Compute pretax financial income for 2012.
(c) Prepare the journal entries to record income tax expense, deferred income taxes, and income taxes payable for 2012 and 2013. Assume taxable income was $980,000 in 2013.
(d) Prepare the income tax expense section of the income statement for 2012, beginning with “Income before income taxes.”
(One Temporary Difference, Tracked for 4 Years, One Permanent Difference, Change in Rate) The pretax financial income of Truttman Company differs from its taxable income throughout each of 4 years as follows.
Year
Pretax Financial Income
Taxable Income
Tax Rate
2012
$290,000
$180,000
35%
2013
320,000
225,000
40%
2014
350,000
260,000
40%
2015
420,000
560,000
40%
Pretax financial income for each year includes a nondeductible expense of $30,000 (never deductible for tax purposes). The remainder of the difference between pretax financial income and taxable income in each period is due to one depreciation temporary difference. No deferred income taxes existed at the beginning of 2012.
Instructions
(a) Prepare journal entries to record income taxes in all 4 years. Assume that the change in the tax rate to 40% was not enacted until the beginning of 2013.
(b) Prepare the income statement for 2013, beginning with Income before income taxes.
(Second Year of Depreciation Difference, Two Differences, Single Rate, Extraordinary Item) The following information has been obtained for the Gocker Corporation.
1. Prior to 2012, taxable income and pretax financial income were identical.
2. Pretax financial income is $1,700,000 in 2012 and $1,400,000 in 2013.
3. On January 1, 2012, equipment costing $1,200,000 is purchased. It is to be depreciated on a straight line basis over 5 years for tax purposes and over 8 years for financial reporting purposes. (Hint: Use the half year convention for tax purposes, as discussed in Appendix 11A.)
4. Interest of $60,000 was earned on tax exempt municipal obligations in 2013.
5. Included in 2013 pretax financial income is an extraordinary gain of $200,000, which is fully taxable.
6. The tax rate is 35% for all periods.
7. Taxable income is expected in all future years.
Instructions
(a) Compute taxable income and income taxes payable for 2013.
(b) Prepare the journal entry to record 2013 income tax expense, income taxes payable, and deferred taxes.
(c) Prepare the bottom portion of Gocker’s 2013 income statement, beginning with “Income before income taxes and extraordinary item.”
(d) Indicate how deferred income taxes should be presented on the December 31, 2013, balance sheet.
(Permanent and Temporary Differences, One Rate) The accounting records of Shinault Inc. show the following data for 2012.
1. Life insurance expense on officers was $9,000.
2. Equipment was acquired in early January for $300,000. Straight line depreciation over a 5 year life is used, with no salvage value. For tax purposes, Shinault used a 30% rate to calculate depreciation.
3. Interest revenue on State of New York bonds totaled $4,000.
4. Product warranties were estimated to be $50,000 in 2012. Actual repair and labor costs related to the warranties in 2012 were $10,000. The remainder is estimated to be paid evenly in 2013 and 2014.
5. Sales on an accrual basis were $100,000. For tax purposes, $75,000 was recorded on the install mentsales method.
6. Fines incurred for pollution violations were $4,200.
7. Pretax financial income was $750,000. The tax rate is 30%.
Instructions
(a) Prepare a schedule starting with pretax financial income in 2012 and ending with taxable income in 2012.
(b) Prepare the journal entry for 2012 to record income taxes payable, income tax expense, and deferred income taxes.
(NOL without Valuation Account) Jennings Inc. reported the following pretax income (loss) and related tax rates during the years 2008–2014.
Pretax Income (loss)
Tax Rate
2008
$ 40,000
30%
2009
25,000
30%
2010
50,000
30%
2011
80,000
40%
2012
(180,000)
45%
2013
70,000
40%
2014
100,000
35%
Pretax financial income (loss) and taxable income (loss) were the same for all years since Jennings began business. The tax rates from 2011–2014 were enacted in 2011.
Instructions
(a) Prepare the journal entries for the years 2012–2014 to record income taxes payable (refundable), income tax expense (benefit), and the tax effects of the loss carryback and carry forward. Assume that Jennings elects the carryback provision where possible and expects to realize the benefits of any loss carry forward in the year that immediately follows the loss year.
(b) Indicate the effect the 2012 entry(ies) has on the December 31, 2012, balance sheet.
(c) Prepare the portion of the income statement, starting with “Operating loss before income taxes,” for 2012.
(d) Prepare the portion of the income statement, starting with “Income before income taxes,” for 2013.
(Two Differences, Two Rates, Future Income Expected) Presented below are two independent situations related to future taxable and deductible amounts resulting from temporary differences existing at December 31, 2012.
1. Mooney Co. has developed the following schedule of future taxable and deductible amounts.
2013
2014
2015
2016
2017
Taxable amounts
$300
$300
$300
$ 300
$300
Deductible amount
—
—
—
(1,600)
—
2. Roesch Co. has the following schedule of future taxable and deductible amounts.
2013
2014
2015
2016
Taxable amounts
$300
$300
$ 300
$300
Deductible amount
—
—
(2,300)
—
Both Mooney Co. and Roesch Co. have taxable income of $4,000 in 2012 and expect to have taxable income in all future years. The tax rates enacted as of the beginning of 2012 are 30% for 2012–2015 and 35% for years thereafter. All of the underlying temporary differences relate to noncurrent assets and liabilities.
Instructions
For each of these two situations, compute the net amount of deferred income taxes to be reported at the end of 2012, and indicate how it should be classified on the balance sheet.
(One Temporary Difference, Tracked 3 Years, Change in Rates, Income Statement Presentation) Crosley Corp. sold an investment on an installment basis. The total gain of $60,000 was reported for financial reporting purposes in the period of sale. The company qualifies to use the installment sales method for tax purposes. The installment period is 3 years; one third of the sale price is collected in the period of sale. The tax rate was 40% in 2012, and 35% in 2013 and 2014. The 35% tax rate was not enacted in law until 2013. The accounting and tax data for the 3 years is shown below.
2012 (40% tax rate)
Financial Accounting
Tax Return
Income before temporary difference
$ 70,000
$70,000
Temporary difference
60,000
20,000
Income
$130,000
$90,000
2013 (35% tax rate)
Income before temporary difference
$ 70,000
$70,000
Temporary difference
–0–
20,000
Income
$ 70,000
$90,000
2014 (35% tax rate)
Income before temporary difference
$ 70,000
$70,000
Temporary difference
–0–
20,000
Income
$ 70,000
$90,000
Instructions
(a) Prepare the journal entries to record the income tax expense, deferred income taxes, and the income taxes payable at the end of each year. No deferred income taxes existed at the beginning of 2012.
(b) Explain how the deferred taxes will appear on the balance sheet at the end of each year. (Assume Installment Accounts Receivable is classified as a current asset.)
(c) Draft the income tax expense section of the income statement for each year, beginning with “Income before income taxes.”
(Two Differences, 2 Years, Compute Taxable Income and Pretax Financial Income) The information below and on page 1194 was disclosed during the audit of Elbert Inc.
1.
Year
Amount Dueper Tax Return
2012
$130,000
2013
104,000
2. On January 1, 2012, equipment costing $600,000 is purchased. For financial reporting purposes, the company uses straight line depreciation over a 5 year life. For tax purposes, the company uses the elective straight line method over a 5 year life. (Hint: For tax purposes, the half year convention as discussed in Appendix 11A must be used.)
3. In January 2013, $225,000 is collected in advance rental of a building for a 3 year period. The entire $225,000 is reported as taxable income in 2013, but $150,000 of the $225,000 is reported as unearned revenue in 2013 for financial reporting purposes. The remaining amount of unearned revenue is to be earned equally in 2014 and 2015.
4. The tax rate is 40% in 2012 and all subsequent periods. (Hint: To find taxable income in 2012 and 2013, the related income taxes payable amounts will have to be “grossed up.”)
5. No temporary differences existed at the end of 2011. Elbert expects to report taxable income in each of the next 5 years.
Instructions
(a) Determine the amount to report for deferred income taxes at the end of 2012, and indicate how it should be classified on the balance sheet.
(b) Prepare the journal entry to record income taxes for 2012.
(c) Draft the income tax section of the income statement for 2012, beginning with “Income before income taxes.” (Hint: You must compute taxable income and then combine that with changes in cumulative temporary differences to arrive at pretax financial income.)
(d) Determine the deferred income taxes at the end of 2013, and indicate how they should be classified on the balance sheet.
(e) Prepare the journal entry to record income taxes for 2013.
(f) Draft the income tax section of the income statement for 2013, beginning with “Income before income taxes.”
(Five Differences, Compute Taxable Income and Deferred Taxes, Draft Income Statement) Wise Company began operations at the beginning of 2013. The following information pertains to this company.
1. Pretax financial income for 2013 is $100,000.
2. The tax rate enacted for 2013 and future years is 40%.
3. Differences between the 2013 income statement and tax return are listed below:
(a) Warranty expense accrued for financial reporting purposes amounts to $7,000. Warranty deductions per the tax return amount to $2,000.
(b) Gross profit on construction contracts using the percentage of completion method per books amounts to $92,000. Gross profit on construction contracts for tax purposes amounts to $67,000.
(c) Depreciation of property, plant, and equipment for financial reporting purposes amounts to $60,000. Depreciation of these assets amounts to $80,000 for the tax return.
(d) A $3,500 fine paid for violation of pollution laws was deducted in computing pretax financial income.
(e) Interest revenue earned on an investment in tax exempt municipal bonds amounts to $1,500. (Assume (a) is short term in nature; assume (b) and (c) are long term in nature.)
4. Taxable income is expected for the next few years.
Instructions
(a) Compute taxable income for 2013.
(b) Compute the deferred taxes at December 31, 2013, that relate to the temporary differences described above. Clearly label them as deferred tax asset or liability.
(c) Prepare the journal entry to record income tax expense, deferred taxes, and income taxes payable for 2013.
(d) Draft the income tax expense section of the income statement, beginning with “Income before income taxes.”
(Basic Accounting for Temporary Differences) Dexter Company appropriately uses the asset liability method to record deferred income taxes. Dexter reports depreciation expense for certain machinery purchased this year using the modified accelerated cost recovery system (MACRS) for income tax purposes and the straight line basis for financial reporting purposes. The tax deduction is the larger amount this year.
Dexter received rent revenues in advance this year. These revenues are included in this year’s taxable income. However, for financial reporting purposes, these revenues are reported as unearned revenues, a current liability.
Instructions
(a) What are the principles of the asset liability approach?
(b) How would Dexter account for the temporary differences?
(c) How should Dexter classify the deferred tax consequences of the temporary differences on its balance sheet?
(Identify Temporary Differences and Classification Criteria) The asset liability approach for recording deferred income taxes is an integral part of generally accepted accounting principles.
Instructions
(a) Indicate whether each of the following independent situations should be treated as a temporary difference or as a permanent difference, and explain why.
(1) Estimated warranty costs (covering a 3 year warranty) are expensed for financial reporting purposes at the time of sale but deducted for income tax purposes when paid.
(2) Depreciation for book and income tax purposes differs because of different bases of carrying the related property, which was acquired in a trade in. The different bases are a result of different rules used for book and tax purposes to compute the basis of property acquired in a trade in.
(3) A company properly uses the equity method to account for its 30% investment in another company. The investee pays dividends that are about 10% of its annual earnings.
(4) A company reports a gain on an involuntary conversion of a nonmonetary asset to a monetary asset. The company elects to replace the property within the statutory period using the total proceeds so the gain is not reported on the current year’s tax return.
(b) Discuss the nature of the deferred income tax accounts and possible classifications in a company’s balance sheet. Indicate the manner in which these accounts are to be reported.
(Accounting and Classification of Deferred Income Taxes)
Part A
This year, Gumowski Company has each of the following items in its income statement.
1. Gross profits on installment sales.
2. Revenues on long term construction contracts.
3. Estimated costs of product warranty contracts.
4. Premiums on officers’ life insurance policies with Gumowski as beneficiary.
Instructions
(a) Under what conditions would deferred income taxes need to be reported in the financial statements?
(b) Specify when deferred income taxes would need to be recognized for each of the items above, and indicate the rationale for such recognition.
Part B
Gumowski Company’s president has heard that deferred income taxes can be classified in different ways in the balance sheet.
Instructions
Identify the conditions under which deferred income taxes would be classified as a noncurrent item in the balance sheet. What justification exists for such classification?
(Explain Future Taxable and Deductible Amounts, How Carryback and Carry forward Affects Deferred Taxes) Maria Rodriquez and Lynette Kingston are discussing accounting for income taxes. They are currently studying a schedule of taxable and deductible amounts that will arise in the future as a result of existing temporary differences. The schedule is as follows.
Current Years
Future Years
2012
2013
2014
2015
2016
Taxable income
$850,000
Taxable amounts
$375,000
$375,000
$375,000
$375,000
Deductible amounts
(2,400,000)
Enacted tax rate
50%
45%
40%
35%
30%
Instructions
(a) Explain the concept of future taxable amounts and future deductible amounts as illustrated in the schedule.
(b) How do the carryback and carryforward provisions affect the reporting of deferred tax assets and deferred tax liabilities?
(Deferred Taxes, Income Effects) Stephanie Delaney, CPA, is the newly hired director of corporate taxation for Acme Incorporated, which is a publicly traded corporation. Ms. Delaney’s first job with Acme was the review of the company’s accounting practices on deferred income taxes. In doing her review, she noted differences between tax and book depreciation methods that permitted Acme to realize a sizable deferred tax liability on its balance sheet. As a result, Acme paid very little in income taxes at that time. Delaney also discovered that Acme has an explicit policy of selling off plant assets before they reversed in the deferred tax liability account. This policy, coupled with the rapid expansion of its plant asset base, allowed Acme to “defer” all income taxes payable for several years, even though it always has reported positive earnings and an increasing EPS. Delaney checked with the legal department and found the policy to be legal, but she’s uncomfortable with the ethics of it.
Instructions
Answer the following questions.
(a) Why would Acme have an explicit policy of selling plant assets before the temporary differences reversed in the deferred tax liability account?
(b) What are the ethical implications of Acme’s “deferral” of income taxes?
(c) Who could be harmed by Acme’s ability to “defer” income taxes payable for several years, despite positive earnings?
(d) In a situation such as this, what are Ms. Delaney’s professional responsibilities as a CPA?
(Application of Years of Service Method) Andrews Company has five employees participating in its defined benefit pension plan. Expected years of future service for these employees at the beginning of 2012 are as follows.
Employee
Future Years of Service
Jim
3
Paul
4
Nancy
5
Dave
6
Kathy
6
On January 1, 2012, the company amended its pension plan, increasing its projected benefit obligation by $72,000.
Instructions
Compute the amount of prior service cost amortization for the years 2012 through 2017 using the years of service method, setting up appropriate schedules.
Parker, Inc., acquires 70 percent of Sawyer Company for $420,000. The remaining 30 percent of Sawyer’s outstanding shares continue to trade at a collective value of $174,000. On the acquisition date, Sawyer has the following accounts:
Book Value
Fair Value
Current assets
$210,000
$210,000
Land
170,000
180,000
Buildings
300,000
330,000
Liabilities
280,000
280,000
The buildings have a 10 year life. In addition, Sawyer holds a patent worth $140,000 that has a fiveyear life but is not recorded on its financial records. At the end of the year, the two companies report the following balances:
Parker
Sawyer
Revenues
($900,000)
($600,000)
Expenses
600,000
400,000
a. Assume that the acquisition took place on January 1. What figures would appear in a consolidated income statement for this year?
b. Assume that the acquisition took place on April 1. Sawyer’s revenues and expenses occurred uniformly throughout the year. What amounts would appear in a consolidated income statement for this year?
On January 1, Beckman, Inc., acquires 60 percent of the outstanding stock of Calvin for $36,000. Calvin Co. has one recorded asset, a specialized production machine with a book value of $10,000 and no liabilities. The fair value of the machine is $50,000, and the remaining useful life is estimated to be 10 years. Any remaining excess fair value is attributable to an unrecorded process trade secret with an estimated future life of 4 years. Calvin’s total acquisition date fair value is $60,000. At the end of the year, Calvin reports the following in its financial statements:
Revenues
$50,000
Machine
$9,000
Common stock
$10,000
Expenses
20,000
Other assets
26,000
Retained earnings
25,000
Net income
$30,000
Total assets
$35,000
Total equity
$35,000
Dividends paid
$5,000
Determine the amounts that Beckman should report in its year end consolidated financial statements for noncontrolling interest in subsidiary income, total noncontrolling interest, Calvin’s machine (net of accumulated depreciation), and the process trade secret.
(One Temporary Difference, Future Taxable Amounts, One Rate, Beginning Deferred Taxes) Brennan Corporation began 2012 with a $90,000 balance in the Deferred Tax Liability account. At the end of 2012, the related cumulative temporary difference amounts to $350,000, and it will reverse evenly over the next 2 years. Pretax accounting income for 2012 is $525,000, the tax rate for all years is 40%, and taxable income for 2012 is $400,000.
Instructions
(a) Compute income taxes payable for 2012.
(b) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2012.
(c) Prepare the income tax expense section of the income statement for 2012, beginning with the line “Income before income taxes.”
(Three Differences, Compute Taxable Income, Entry for Taxes) Havaci Company reports pretax financial income of $80,000 for 2012. The following items cause taxable income to be different than pretax financial income.
1. Depreciation on the tax return is greater than depreciation on the income statement by $16,000.
2. Rent collected on the tax return is greater than rent earned on the income statement by $27,000.
3. Fines for pollution appear as an expense of $11,000 on the income statement. Havaci’s tax rate is 30% for all years, and the company expects to report taxable income in all future years. There are no deferred taxes at the beginning of 2012.
Instructions
(a) Compute taxable income and income taxes payable for 2012.
(b) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2012.
(c) Prepare the income tax expense section of the income statement for 2012, beginning with the line “Income before income taxes.”
(d) Compute the effective income tax rate for 2012.
(Identify Temporary or Permanent Differences) Listed below are items that are commonly accounted for differently for financial reporting purposes than they are for tax purposes.
Instructions
For each item below, indicate whether it involves:
(1) A temporary difference that will result in future deductible amounts and, therefore, will usually give rise to a deferred income tax asset.
(2) A temporary difference that will result in future taxable amounts and, therefore, will usually give rise to a deferred income tax liability.
(3) A permanent difference. Use the appropriate number to indicate your answer for each.
(a) ____ The MACRS depreciation system is used for tax purposes, and the straight line depreciation method is used for financial reporting purposes for some plant assets.
(b) ______ A landlord collects some rents in advance. Rents received are taxable in the period when they are received.
(c) ______ Expenses are incurred in obtaining tax exempt income.
(d) ______ Costs of guarantees and warranties are estimated and accrued for financial reporting purposes.
(e) ______ Installment sales of investments are accounted for by the accrual method for financial reporting purposes and the installment sales method for tax purposes.
(f) ______ Interest is received on an investment in tax exempt municipal obligations.
(g) ______ For some assets, straight line depreciation is used for both financial reporting purposes and tax purposes, but the assets’ lives are shorter for tax purposes.
(h) ______ Proceeds are received from a life insurance company because of the death of a key officer. (The company carries a policy on key officers.)
(i) ______ The tax return reports a deduction for 80% of the dividends received from U.S. corporations. The cost method is used in accounting for the related investments for financial reporting purposes.
(j) ______ Estimated losses on pending lawsuits and claims are accrued for books. These losses are tax deductible in the period(s) when the related liabilities are settled.
(k) ______ Expenses on stock options are accrued for financial reporting purposes.
Complete the following statements by filling in the blanks.
(a) In a period in which a taxable temporary difference reverses, the reversal will cause taxable income to be _______ (less than, greater than) pretax financial income.
(b) If a $68,000 balance in Deferred Tax Asset was computed by use of a 40% rate, the underlying cumulative temporary difference amounts to $_______.
(c) Deferred taxes ________ (are, are not) recorded to account for permanent differences.
(d) If a taxable temporary difference originates in 2013, it will cause taxable income for 2013 to be ________ (less than, greater than) pretax financial income for 2013.
(e) If total tax expense is $50,000 and deferred tax expense is $65,000, then the current portion of the expense computation is referred to as current tax _______(expense, benefit) of $_______.
(f) If a corporation’s tax return shows taxable income of $105,000 for Year 2 and a tax rate of 40%, how much will appear on the December 31, Year 2, balance sheet for “Income taxes payable” if the company has made estimated tax payments of $36,500 for Year 2? $________.
(g) An increase in the Deferred Tax Liability account on the balance sheet is recorded by a _______ (debit, credit) to the Income Tax Expense account.
(h) An income statement that reports current tax expense of $82,000 and deferred tax benefit of $23,000 will report total income tax expense of $________.
(i) A valuation account is needed whenever it is judged to be _______ that a portion of a deferred tax asset _______ (will be, will not be) realized.
(j) If the tax return shows total taxes due for the period of $75,000 but the income statement shows total income tax expense of $55,000, the difference of $20,000 is referred to as deferred tax _______(expense, benefit).
(Two Temporary Differences, One Rate, 3 Years) Gordon Company has two temporary differences between its pretax financial income and taxable income. The information is shown below.
2012
2013
2014
Pretax financial income
$840,000
$910,000
$945,000
Excess depreciation expense on tax return
(30,000)
(40,000)
(20,000)
Excess warranty expense in financial income
20,000
10,000
8,000
Taxable income
$830,000
$880,000
$933,000
The income tax rate for all years is 40%.
Instructions
(a) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2012, 2013, and 2014.
(b) Assuming there were no temporary differences prior to 2012, indicate how deferred taxes will be reported on the 2014 balance sheet. Gordon’s product warranty is for 12 months.
(c) Prepare the income tax expense section of the income statement for 2014, beginning with the line “Pretax financial income.”
(Carryback and Carryforward of NOL, No Valuation Account, No Temporary Differences) The pretax financial income (or loss) figures for Synergetics Company are as follows.
2008
$160,000
2009
250,000
2010
90,000
2011
(160,000)
2012
(350,000)
2013
120,000
2014
100,000
Pretax financial income (or loss) and taxable income (loss) were the same for all years involved. Assume a 45% tax rate for 2008 and 2009 and a 40% tax rate for the remaining years.
Instructions
Prepare the journal entries for the years 2010 to 2014 to record income tax expense and the effects of the net operating loss carrybacks, and carry forwards, assuming Synergetic Company uses the carryback provision. All income and losses relate to normal operations. (In recording the benefits of a loss carry forward, assume that no valuation account is deemed necessary.)
(Two NOLs, No Temporary Differences, No Valuation Account, Entries and Income Statement) Lanier Corporation has pretax financial income (or loss) equal to taxable income (or loss) from 2005 through 2013 as follows.
Income (Loss)
Tax Rate
2005
$29,000
30%
2006
40,000
30%
2007
22,000
35%
2008
48,000
50%
2009
(150,000)
40%
2010
90,000
40%
2011
30,000
40%
2012
105,000
40%
2013
(50,000)
45%
Pretax financial income (loss) and taxable income (loss) were the same for all years since Lanier has been in business. Assume the carryback provision is employed for net operating losses. In recording the benefits of a loss carryforward, assume that it is more likely than not that the related benefits will be realized.
Instructions
(a) What entry(ies) for income taxes should be recorded for 2009?
(b) Indicate what the income tax expense portion of the income statement for 2009 should look like. Assume all income (loss) relates to continuing operations.
(c) What entry for income taxes should be recorded in 2010?
(d) How should the income tax expense section of the income statement for 2010 appear?
(e) What entry for income taxes should be recorded in 2013?
(f) How should the income tax expense section of the income statement for 2013 appear?
(Three Differences, Classify Deferred Taxes) At December 31, 2012, Cascade Company had a net deferred tax liability of $450,000. An explanation of the items that compose this balance is as follows.
Temporary Differences
Resulting Balances in Deferred Taxes
1. Excess of tax depreciation over book depreciation
$200,000
2. Accrual, for book purposes, of estimated loss contingency from pending lawsuit that is expected to be settled in 2013. The loss will be deducted on the tax return when paid.
(50,000)
3. Accrual method used for book purposes and installment sales method used for tax purposes for an isolated installment sale of an investment.
300,000
$450,000
In analyzing the temporary differences, you find that $30,000 of the depreciation temporary difference will reverse in 2013, and $120,000 of the temporary difference due to the installment sale will reverse in 2013.The tax rate for all years is 40%.
Instructions
Indicate the manner in which deferred taxes should be presented on Cascade Company’s December 31, 2012, balance sheet.
(One Difference, Multiple Rates, Effect of Beginning Balance versus No Beginning Deferred Taxes) At the end of 2012, Wasicsko Company has $180,000 of cumulative temporary differences that will result in reporting future taxable amounts as follows.
2013
$ 70,000
2014
50,000
2015
40,000
2016
20,000
$180,000
Tax rates enacted as of the beginning of 2011 are:
2011 and 2012
40%
2013 and 2014
30%
2015 and later
25%
Wasicsko’s taxable income for 2012 is $340,000. Taxable income is expected in all future years.
Instructions
(a) Prepare the journal entry for Wasicsko to record income taxes payable, deferred income taxes, and income tax expense for 2012, assuming that there were no deferred taxes at the end of 2011.
(b) Prepare the journal entry for Wasicsko to record income taxes payable, deferred income taxes, and income tax expense for 2012, assuming that there was a balance of $22,000 in a Deferred Tax Liability account at the end of 2011.
(Deferred Tax Asset with and without Valuation Account) Callaway Corp. has a deferred tax asset account with a balance of $150,000 at the end of 2012 due to a single cumulative temporary difference of $375,000. At the end of 2013, this same temporary difference has increased to a cumulative amount of $500,000. Taxable income for 2013 is $850,000. The tax rate is 40% for all years. No valuation allowance related to the deferred tax asset is in existence at the end of 2012.
Instructions
(a) Record income tax expense, deferred income taxes, and income taxes payable for 2013, assuming that it is more likely than not that the deferred tax asset will be realized.
(b) Assuming that it is more likely than not that $30,000 of the deferred tax asset will not be realized, prepare the journal entry at the end of 2013 to record the valuation account.
(Deferred Tax Liability, Change in Tax Rate, Prepare Section of Income Statement) Sharrer Inc.’s only temporary difference at the beginning and end of 2012 is caused by a $2 million deferred gain for tax purposes for an installment sale of a plant asset, and the related receivable (only one half of which is classified as a current asset) is due in equal installments in 2013 and 2014. The related deferred tax liability at the beginning of the year is $800,000. In the third quarter of 2012, a new tax rate of 34% is enacted into law and is scheduled to become effective for 2014. Taxable income for 2012 is $5,000,000, and taxable income is expected in all future years.
Instructions
(a) Determine the amount reported as a deferred tax liability at the end of 2012. Indicate proper classification(s).
(b) Prepare the journal entry (if any) necessary to adjust the deferred tax liability when the new tax rate is enacted into law.
(c) Draft the income tax expense portion of the income statement for 2012. Begin with the line “Income before income taxes.” Assume no permanent differences exist.
(Two Temporary Differences, Tracked through 3 Years, Multiple Rates) Taxable income and pretax financial income would be identical for Jones Co. except for its treatments of gross profit on installment sales and estimated costs of warranties. The following income computations have been prepared.
Taxable income
2012
2013
2014
Excess of revenues over expenses
(excluding two temporary differences)
$160,000
$210,000
$90,000
Installment income collected
8,000
8,000
8,000
Expenditures for warranties
(5,000)
(5,000)
(5,000)
Taxable income
$163,000
$213,000
$93,000
Pretax financial income
2012
2013
2014
Excess of revenues over expenses (excluding two temporary differences)
$160,000
$210,000
$90,000
Installment gross profit earned
24,000
–0–
–0–
Estimated cost of warranties
(15,000)
–0–
–0–
Income before taxes
$169,000
$210,000
$90,000
The tax rates in effect are: 2012, 45%; 2013 and 2014, 40%. All tax rates were enacted into law on January 1, 2012. No deferred income taxes existed at the beginning of 2012. Taxable income is expected in all future years.
Instructions
Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2012, 2013, and 2014.
(Three Differences, Multiple Rates, Future Taxable Income) During 2012, Graham Co.’s first year of operations, the company reports pretax financial income of $250,000. Graham’s enacted tax rate is 40% for 2012 and 35% for all later years. Graham expects to have taxable income in each of the next 5 years. The effects on future tax returns of temporary differences existing at December 31, 2012, are summarized below.
Future Years
2013
2014
2015
2016
2017
Total
Future taxable (deductible) amounts:
Installment sales
$32,000
$32,000
$32,000
$ 96,000
Depreciation
6,000
6,000
6,000
$6,000
$6,000
30,000
Unearned rent
(50,000)
(50,000)
(100,000)
Instructions
(a) Complete the schedule below to compute deferred taxes at December 31, 2012.
(b) Compute taxable income for 2012.
(c) Prepare the journal entry to record income taxes payable, deferred taxes, and income tax expense for 2012.
(Two Differences, One Rate, Beginning Deferred Balance, Compute Pretax Financial Income) Shamess Co. establishes a $90 million liability at the end of 2012 for the estimated litigation settlement for manufacturing defects. All related costs will be paid and deducted on the tax return in 2013. Also, at the end of 2012, the company has $50 million of temporary differences due to excess depreciation for tax purposes, $7 million of which will reverse in 2013. The enacted tax rate for all years is 40%, and the company pays taxes of $64 million on $160 million of taxable income in 2012. Shamess expects to have taxable income in 2013.
Instructions
(a) Determine the deferred taxes to be reported at the end of 2012.
(b) Indicate how the deferred taxes computed in (a) are to be reported on the balance sheet.
(c) Assuming that the only deferred tax account at the beginning of 2012 was a deferred tax liability of $10,000,000, draft the income tax expense portion of the income statement for 2012, beginning with the line “Income before income taxes.”
(Two Differences, No Beginning Deferred Taxes, Multiple Rates) Macinski Inc., in its first year of operations, has the following differences between the book basis and tax basis of its assets and liabilities at the end of 2012.
Book Basis
Tax Basis
Equipment (net)
$400,000
$340,000
Estimated warranty liability
$150,000
$ –0–
It is estimated that the warranty liability will be settled in 2013. The difference in equipment (net) will result in taxable amounts of $20,000 in 2013, $30,000 in 2014, and $10,000 in 2015. The company has taxable income of $550,000 in 2012. As of the beginning of 2012, the enacted tax rate is 34% for 2012–2014, and 30%
for 2015. Macinski expects to report taxable income through 2015.
Instructions
(a) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2012.
(b) Indicate how deferred income taxes will be reported on the balance sheet at the end of 2012.
(Two Temporary Differences, Multiple Rates, Future Taxable Income) Flynn Inc. has two temporary differences at the end of 2012. The first difference stems from installment sales, and the second one results from the accrual of a loss contingency. Flynn’s accounting department has developed a schedule of future taxable and deductible amounts related to these temporary differences as follows.
2013
2014
2015
2016
Taxable amounts
$40,000
$50,000
$60,000
$90,000
Deductible amounts
(15,000)
(19,000)
$40,000
$35,000
$41,000
$90,000
As of the beginning of 2012, the enacted tax rate is 34% for 2012 and 2013, and 38% for 2014–2017. At the beginning of 2012, the company had no deferred income taxes on its balance sheet. Taxable income for 2012 is $400,000. Taxable income is expected in all future years.
Instructions
(a) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2012.
(b) Indicate how deferred income taxes would be classified on the balance sheet at the end of 2012.
(Two Differences, One Rate, First Year) The differences between the book basis and tax basis of the assets and liabilities of Morgan Corporation at the end of 2012 are presented below.
Book Basis
Tax Basis
Accounts receivable
$50,000
$–0–
Litigation liability
20,000
–0–
It is estimated that the litigation liability will be settled in 2013. The difference in accounts receivable will result in taxable amounts of $30,000 in 2013 and $20,000 in 2014. The company has taxable income of $300,000 in 2012 and is expected to have taxable income in each of the following 2 years. Its enacted tax rate is 34% for all years. This is the company’s first year of operations. The operating cycle of the business is 2 years.
Instructions
(a) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2012.
(b) Indicate how deferred income taxes will be reported on the balance sheet at the end of 2012.
(NOL Carryback and Carry forward, Valuation Account versus No Valuation Account) Sondgeroth Inc. reports the following pretax income (loss) for both financial reporting purposes and tax purposes. (Assume the carryback provision is used for a net operating loss.)
Year
Pretax Income (Loss)
Tax Rate
2011
$110,000
34%
2012
90,000
34%
2013
(260,000)
38%
2014
220,000
38%
The tax rates listed were all enacted by the beginning of 2011.
Instructions
(a) Prepare the journal entries for the years 2011–2014 to record income tax expense (benefit), income taxes payable (refundable), and the tax effects of the loss carryback and carry forward, assuming that at the end of 2013 the benefits of the loss carry forward are judged more likely than not to be realized in the future.
(b) Using the assumption in (a), prepare the income tax section of the 2013 income statement, beginning with the line “Operating loss before income taxes.”
(c) Prepare the journal entries for 2013 and 2014, assuming that based on the weight of available evidence, it is more likely than not that one fourth of the benefits of the loss carry forward will not be realized.
(d) Using the assumption in (c), prepare the income tax section of the 2013 income statement, beginning with the line “Operating loss before income taxes.”
(Installment Sales Income Statements) Chantal Stores sells merchandise on open account as well as on installment terms.
2012
2013
2014
Sales on account
$385,000
$426,000
$525,000
Installment sales
320,000
275,000
380,000
Collections on installment sales
Made in 2012
100000
90,000
40,000
Made in 2013
110,000
140,000
Made in 2014
125,000
Cost of sales
Sold on account
270,000
277,000
341,000
Sold on installment
214,400
176,000
228,000
Selling expenses
77,000
87,000
92,000
Administrative expenses
50,000
51,000
52,000
Instructions
From the data above, which cover the 3 years since Chantal Stores commenced operations, determine the net income for each year, applying the installment sales method of accounting.
(Installment Sales Computations and Entries) Paul Dobson Stores sell appliances for cash and also on the installment plan. Entries to record cost of sales are made monthly.
PAUL DOBSON STORES TRIAL BALANCE DECEMBER 31, 2013
Dr.
Cr.
Cash
$153,000
Installment Accounts Receivable, 2012
56,000
Installment Accounts Receivable, 2013
91,000
Inventory—New Merchandise
123,200
Inventory—Repossessed Merchandise
24,000
Accounts Payable
$ 98,500
Deferred Gross Profit, 2012
45,600
Capital Stock
170,000
Retained Earnings
93,900
Sales
343,000
Installment Sales
200,000
Cost of Goods Sold
255,000
Cost of Installment Sales
120,000
Loss on Repossession
800
Operating Expenses
128,000
$951,000
$951,000
The accounting department has prepared the following analysis of cash receipts for the year.
Cash sales (including repossessed merchandise)
$424,000
Installment accounts receivable, 2012
96,000
Installment accounts receivable, 2013
109,000
Other
36,000
Total
$665,000
Repossessions recorded during the year are summarized as follows.
2012
Uncollected balance
$8,000
Loss on repossession
800
Repossessed merchandise
4,800
Instructions
From the trial balance and accompanying information:
(a) Compute the rate of gross profit on installment sales for 2012 and 2013.
(b) Prepare closing entries as of December 31, 2013, under the installment sales method of accounting.
(c) Prepare an income statement for the year ended December 31, 2013. Include only the realized gross profit in the income statement.
(Installment Sales Computation and Entries—Periodic Inventory) Mantle Inc. sells merchandise for cash and also on the installment plan. Entries to record cost of goods sold are made at the end of each year. Repossessions of merchandise (sold in 2012) were made in 2013 and were recorded correctly as follows.
Deferred Gross Profit, 2012
7,200
Repossessed Merchandise
8,000
Loss on Repossession
2,800
Installment Accounts Receivable, 2012
18,000
Part of this repossessed merchandise was sold for cash during 2013, and the sale was recorded by a debit to Cash and a credit to Sales Revenue. The inventory of repossessed merchandise on hand December 31, 2013, is $4,000; of new merchandise, $127,400. There was no repossessed merchandise on hand January 1, 2013. Collections on accounts receivable during 2013 were:
Installment Accounts Receivable, 2012
$80,000
Installment Accounts Receivable, 2013
50,000
The cost of the merchandise sold under the installment plan during 2013 was $111,600. The rate of gross profit on 2012 and on 2013 installment sales can be computed from the information given.
MANTLE INC. TRIAL BALANCE DECEMBER 31, 2013
Dr.
Cr.
Cash
$118,400
Installment Accounts Receivable, 2012
80,000
Installment Accounts Receivable, 2013
130,000
Inventory, Jan. 1, 2013
120,000
Repossessed Merchandise
8,000
Accounts Payable
$ 47,200
Deferred Gross Profit, 2012
64,000
Common Stock
200,000
Retained Earnings
40,000
Sales Revenue
400,000
Installment Sales
180,000
Purchases
360,000
Loss on Repossession
2,800
Operating Expenses
112,000
$931,200
$931,200
Instructions
(a) From the trial balance and other information given above, prepare adjusting and closing entries as of December 31, 2013.
(b) Prepare an income statement for the year ended December 31, 2013. Include only the realized gross profit in the income statement.
(Installment Repossession Entries) Selected transactions of TV Land Company are presented below.
1. A television set costing $540 is sold to Jack Matre on November 1, 2012, for $900. Matre makes a down payment of $300 and agrees to pay $30 on the first of each month for 20 months thereafter.
2. Matre pays the $30 installment due December 1, 2012.
3. On December 31, 2012, the appropriate entries are made to record profit realized on the installment sales.
4. The first seven 2013 installments of $30 each are paid by Matre. (Make one entry.)
5. In August 2013, the set is repossessed after Matre fails to pay the August 1 installment and indicates that he will be unable to continue the payments. The estimated fair value of the repossessed set is $100.
Instructions
Prepare journal entries to record the transactions above on the books of TV Land Company. Closing entries should not be made.
(Installment Sales Computations and Schedules) Saprano Company, on January 2, 2012, entered into a contract with a manufacturing company to purchase room size air conditioners and to sell the units on an installment plan with collections over approximately 30 months with no carrying charge. For income tax purposes Saprano Company elected to report income from its sales of air conditioners according to the installment sales method. Purchases and sales of new units were as follows.
Units Purchased
Units Sold
Year
Quantity
Price Each
Quantity
Price Each
2012
1,400
$130
1,100
$200
2013
1,200
112
1,500
170
2014
900
136
800
205
Collections on installment sales were as follows.
Collections Received
2012
2013
2014
2012 sales
$42,000
$88,000
$ 80,000
2013 sales
51,000
110,000
2014 sales
34,600
In 2014, 50 units from the 2013 sales were repossessed and sold for $120 each on the installment plan. At the time of repossession, $2,000 had been collected from the original purchasers, and the units had a fair value of $3,000. General and administrative expenses for 2014 were $60,000. No charge has been made against current income for the applicable insurance expense from a 3 year policy expiring June 30, 2015, costing $7,200, and for an advance payment of $12,000 on a new contract to purchase air conditioners beginning January 2, 2015.
Instructions
Assuming that the weighted average method is used for determining the inventory cost, including repossessed merchandise, prepare schedules computing for 2012, 2013, and 2014:
(a) (1) The cost of goods sold on installments.
(2) The average unit cost of goods sold on installments for each year.
(b) The gross profit percentages for 2012, 2013, and 2014.
(c) The gain or loss on repossessions in 2014.
(d) The net income from installment sales for 2014. (Ignore income taxes.)
(Completed Contract Method) Monat Construction Company, Inc., entered into a firm fixed price contract with Hyatt Clinic on July 1, 2012, to construct a four story office building. At that time, Monat estimated that it would take between 2 and 3 years to complete the project. The total contract price for construction of the building is $4,400,000. Monat appropriately accounts for this contract under the completed contract method in its financial statements and for income tax reporting. The building was deemed substantially completed on December 31, 2014. Estimated percentage of completion, accumulated contract costs incurred, estimated costs to complete the contract, and accumulated billings to the Hyatt Clinic under the contract are shown below.
At December 31, 2012
At December 31, 2013
At December 31, 2014
Percentage of completion
30%
70%
100%
Contract costs incurred
$1,140,000
$3,290,000
$4,800,000
Estimated costs to complete the contract
$2,660,000
$1,410,000
–0–
Billings to Hyatt Clinic
$1,400,000
$2,500,000
$4,300,000
Instructions
(a) Prepare schedules to compute the amount to be shown as “Cost of uncompleted contract in excess of related billings” or “Billings on uncompleted contract in excess of related costs” at December 31, 2012, 2013, and 2014. (Ignore income taxes.) Show supporting computations in good form.
(b) Prepare schedules to compute the profit or loss to be recognized as a result of this contract for the years ended December 31, 2012, 2013, and 2014. (Ignore income taxes.) Show supporting computations in good form.
(Comprehensive Problem—Long Term Contracts) You have been engaged by Buhl Construction Company to advise it concerning the proper accounting for a series of long term contracts. Buhl commenced doing business on January 1, 2012. Construction activities for the first year of operations are shown below. All contract costs are with different customers, and any work remaining at December 31, 2012, is expected to be completed in 2013.
Project
Total Contract Price
Billings Through 12/31/12
Cash Collections Through 12/31/12
Contract Costs Incurred Through 12/31/12
Estimated Additional Costs to Complete
A
$ 300,000
$200,000
$180,000
$248,000
$ 72,000
B
350,000
110,000
105,000
67,800
271,200
C
280,000
280,000
255,000
186,000
–0–
D
200,000
35,000
25,000
118,000
87,000
E
240,000
205,000
200,000
190,000
10,000
$1,370,000
$830,000
$765,000
$809,800
$440,200
Instructions
(a) Prepare a schedule to compute gross profit (loss) to be reported, unbilled contract costs and recognized profit, and billings in excess of costs and recognized profit using the percentage of completion method.
(b) Prepare a partial income statement and balance sheet to indicate how the information would be reported for financial statement purposes.
(c) Repeat the requirements for part (a), assuming Buhl uses the completed contract method.
(d) Using the responses above for illustrative purposes, prepare a brief report comparing the conceptual merits (both positive and negative) of the two revenue recognition approaches.
(Revenue Recognition—Alternative Methods) Peterson Industries has three operating divisions—Farber Mining, Glesen Paperbacks, and Enyart Protection Devices. Each division maintains its own accounting system and method of revenue recognition. Farber Mining Farber Mining specializes in the extraction of precious metals such as silver, gold, and platinum. During the fiscal year ended November 30, 2012, Farber entered into contracts worth $2,250,000 and shipped metals worth $2,000,000. A quarter of the shipments were made from inventories on hand at the beginning of the fiscal year, and the remainders were made from metals that were mined during the year. Mining totals for the year, valued at market prices, were silver at $750,000, gold at $1,400,000, and platinum at $490,000. Farber uses the completion of production method to recognize revenue because its operations meet the specified criteria, i.e., reasonably assured sales prices, interchangeable units, and insignificant distribution costs. Enyart Paperbacks Enyart Paperbacks sells large quantities of novels to a few book distributors that in turn sell to several national chains of bookstores. Enyart allows distributors to return up to 30% of sales, and distributors give the same terms to bookstores. While returns from individual titles fluctuate greatly, the returns from distributors have averaged 20% in each of the past 5 years. A total of $7,000,000 of paperback novel sales were made to distributors during the fiscal year. On November 30, 2012, $2,200,000 of fiscal 2012 sales were still subject to return privileges over the next 6 months. The remaining $4,800,000 of fiscal 2012 sales had actual returns of 21%. Sales from fiscal 2011 totaling $2,500,000 were collected in fiscal 2012, with less than 18% of sales returned. Enyart records revenue according to the method referred to as revenue recognition when the right of return exits, because all applicable criteria for use of this method are met by Enyart’s operations. Glesen Protection Devices Glesen Protection Devices works through manufacturers’ agents in various cities. Orders for alarm systems and down payments are forwarded from agents, and Glesen ships the goods f.o.b. shipping point. Customers are billed for the balance due plus actual shipping costs. The firm received orders for $6,000,000 of goods during the fiscal year ended November 30, 2012. Down payments of $600,000 were received, and $5,000,000 of goods were billed and shipped. Actual freight costs of $100,000 were also billed. Commissions of 10% on product price were paid to manufacturers’ agents after the goods were shipped to customers. Such goods are warranted for 90 days after shipment, and warranty returns have been about 1% of sales. Revenue is recognized at the point of sale by Glesen.
Instructions
(a) There are a variety of methods for revenue recognition. Define and describe each of the following methods of revenue recognition, and indicate whether each is in accordance with generally accepted accounting principles.
(1) Completion of production method.
(2) Percentage of completion method.
(3) Installment sales method.
(b) Compute the revenue to be recognized in the fiscal year ended November 30, 2012, for
(Recognition of Revenue—Theory) Revenue is usually recognized at the point of sale. Under special circumstances, however, bases other than the point of sale are used for the timing of revenue recognition.
Instructions
(a) Why is the point of sale usually used as the basis for the timing of revenue recognition?
(b) Disregarding the special circumstances when bases other than the point of sale are used, discuss the merits of each of the following objections to the sale basis of revenue recognition:
(1) It is too conservative because revenue is earned throughout the entire process of production.
(2) It is not conservative enough because accounts receivable do not represent disposable funds, sales returns and allowances may be made, and collection and bad debt expenses may be incurred in a later period.
(c) Revenue may also be recognized (1) during production and (2) when cash is received. For each of these two bases of timing revenue recognition, give an example of the circumstances in which it is properly used and discuss the accounting merits of its use in lieu of the sale basis.
(Recognition of Revenue—Bonus Dollars) Griseta & Dubel Inc. was formed early this year to sell merchandise credits to merchants who distribute the credits free to their customers. For example, customers can earn additional credits based on the dollars they spend with a merchant (e.g., airlines and hotels). Accounts for accumulating the credits and catalogs illustrating the merchandise for which the credits may be exchanged are maintained online. Centers with inventories of merchandise premiums have been established for redemption of the credits. Merchants may not return unused credits to Griseta & Dubel. The following schedule expresses Griseta & Dubel’s expectations as to percentages of a normal month’s activity that will be attained. For this purpose, a “normal month’s activity” is defined as the level of operations expected when expansion of activities ceases or tapers off to a stable rate. The company expects that this level will be attained in the third year and that sales of credits will average $6,000,000 per month throughout the third year.
Month
Actual Credit Sales Percent
Merchandise Premium Purchases Percent
Credit Redemptions Percent
6th
30%
40%
10%
12th
60
60
45
18th
80
80
70
24th
90
90
80
30th
100
100
95
Griseta & Dubel plans to adopt an annual closing date at the end of each 12 months of operation.
Instructions
(a) Discuss the factors to be considered in determining when revenue should be recognized in measuring the income of a business enterprise.
(b) Discuss the accounting alternatives that should be considered by Griseta & Dubel Inc. for the recognition of its revenues and related expenses.
(c) For each accounting alternative discussed in (b), give balance sheet accounts that should be used and indicate how each should be classified.
(Recognition of Revenue from Subscriptions) Cutting Edge is a monthly magazine that has been on the market for 18 months. It currently has a circulation of 1.4 million copies. Negotiations are underway to obtain a bank loan in order to update the magazine’s facilities. They are producing close to capacity and expect to grow at an average of 20% per year over the next 3 years. After reviewing the financial statements of Cutting Edge, Andy Rich, the bank loan officer, had indicated that a loan could be offered to Cutting Edge only if it could increase its current ratio and decrease its debt to equity ratio to a specified level. Jonathan Embry, the marketing manager of Cutting Edge, has devised a plan to meet these requirements. Embry indicates that an advertising campaign can be initiated to immediately increase circulation. The potential customers would be contacted after the purchase of another magazine’s mailing list. The campaign would include:
1. An offer to subscribe to Cutting Edge at 3/4 the normal price.
2. A special offer to all new subscribers to receive the most current world atlas whenever requested at a guaranteed price of $2.
3. An unconditional guarantee that any subscriber will receive a full refund if dissatisfied with the magazine. Although the offer of a full refund is risky, Embry claims that few people will ask for a refund after receiving half of their subscription issues. Embry notes that other magazine companies have tried this sales promotion technique and experienced great success. Their average cancellation rate was 25%. On average, each company increased its initial circulation threefold and in the long run increased circulation to twice that which existed before the promotion. In addition, 60% of the new subscribers are expected to take advantage of the atlas premium. Embry feels confident that the increased subscriptions from the advertising campaign will increase the current ratio and decrease the debt to equity ratio. You are the controller of Cutting Edge and must give your opinion of the proposed plan.
Instructions
(a) When should revenue from the new subscriptions be recognized?
(b) How would you classify the estimated sales returns stemming from the unconditional guarantee?
(c) How should the atlas premium be recorded? Is the estimated premium claims a liability? Explain.
(d) Does the proposed plan achieve the goals of increasing the current ratio and decreasing the debt to equity ratio?
(Long Term Contract—Percentage of Completion) Widjaja Company is accounting for a longterm construction contract using the percentage of completion method. It is a 4 year contract that is currently in its second year. The latest estimates of total contract costs indicate that the contract will be completed at a profit to Widjaja Company.
Instructions
(a) What theoretical justification is there for Widjaja Company’s use of the percentage of completion method?
(b) How would progress billings be accounted for? Include in your discussion the classification of progress billings in Widjaja Company financial statements.
(c) How would the income recognized in the second year of the 4 year contract be determined using the cost to cost method of determining percentage of completion?
(d) What would be the effect on earnings per share in the second year of the 4 year contract of using the percentage of completion method instead of the completed contract method? Discuss.
(Revenue Recognition—Real Estate Development) Lillehammer Lakes is a new recreational real estate development which consists of 500 lake front and lake view lots. As a special incentive to the first 100 buyers of lake view lots, the developer is offering 3 years of free financing on 10 year, 12% notes, no down payment, and one week at a nearby established resort (to be used in the next 3 months)—“a $1,200 value.” The normal price per lot is $15,000. The cost per lake view lot to the developer is an estimated average of $3,000. The development costs continue to be incurred; the actual average cost per lot is not known at this time. The resort promotion cost is $700 per lot. The notes are held by Harper Corp., a wholly owned subsidiary.
Instructions
(a) Discuss the revenue recognition and gross profit measurement issues raised by this situation.
(b) How would the developer’s past financial and business experience influence your decision concerning the recording of these transactions?
(c) Assume 50 people have accepted the offer, signed 10 year notes, and have stayed at the local resort.
Prepare the journal entries that you believe are proper.
(d) What should be disclosed in the notes to the financial statements?
(Revenue Recognition) Nimble Health and Racquet Club (NHRC), which operates eight clubs in the Chicago metropolitan area, offers one year memberships. The members may use any of the eight facilities but must reserve racquetball court time and pay a separate fee before using the court. As an incentive to new customers, NHRC advertised that any customers not satisfied for any reason could receive a refund of the remaining portion of unused membership fees. Membership fees are due at the beginning of the individual membership period. However, customers are given the option of financing the membership fee over the membership period at a 9% interest rate. Some customers have expressed a desire to take only the regularly scheduled aerobic classes without paying for a full membership. During the current fiscal year, NHRC began selling coupon books for aerobic classes to accommodate these customers. Each book is dated and contains 50 coupons that may be redeemed for any regularly scheduled aerobics class over a one year period. After the one year period, unused coupons are no longer valid. During 2010, NHRC expanded into the health equipment market by purchasing a local company that manufactures rowing machines and cross country ski machines. These machines are used in NHRC’s facilities and are sold through the clubs and mail order catalogs. Customers must make a 20% down payment when placing an equipment order; delivery is 60–90 days after order placement. The machines are sold with a 2 year unconditional guarantee. Based on past experience, NHRC expects the costs to repair machines under guarantee to be 4% of sales. NHRC is in the process of preparing financial statements as of May 31, 2013, the end of its fiscal year. Marvin Bush, corporate controller, expressed concern over the company’s performance for the year and decided to review the preliminary financial statements prepared by Joyce Kiley, NHRC’s assistant controller. After reviewing the statements, Bush proposed that the following changes be reflected in the May 31, 2013, published financial statements.
1. Membership revenue should be recognized when the membership fee is collected.
2. Revenue from the coupon books should be recognized when the books are sold.
3. Down payments on equipment purchases and expenses associated with the guarantee on the rowing and cross country machines should be recognized when paid. Kiley indicated to Bush that the proposed changes are not in accordance with generally accepted accounting principles, but Bush insisted that the changes be made. Kiley believes that Bush wants to manage income to forestall any potential financial problems and increase his year end bonus. At this point, Kiley is unsure what action to take.
Instructions
(a) (1) Describe when Nimble Health and Racquet Club (NHRC) should recognize revenue from membership fees, court rentals, and coupon book sales.
(2) Describe how NHRC should account for the down payments on equipment sales, explaining when this revenue should be recognized.
(3) Indicate when NHRC should recognize the expense associated with the guarantee of the rowing and cross country machines.
(b) Discuss why Marvin Bush’s proposed changes and his insistence that the financial statement changes be made is unethical. Structure your answer around or to include the following aspects of ethical conduct: competence, confidentiality, integrity, and/or objectivity.
(c) Identify some specific actions Joyce Kiley could take to resolve this situation.
(Revenue Recognition—Membership Fees) Midwest Health Club (MHC) offers one year memberships. Membership fees are due in full at the beginning of the individual membership period. As an incentive to new customers, MHC advertised that any customers not satisfied for any reason could receive a refund of the remaining portion of unused membership fees. As a result of this policy, Richard Nies, corporate controller, recognized revenue ratably over the life of the membership. MHC is in the process of preparing its year end financial statements. Rachel Avery, MHC’s treasurer, is concerned about the company’s lackluster performance this year. She reviews the financial statements Nies prepared and tells Nies to recognize membership revenue when the fees are received.
(Franchise Revenue) Amigos Burrito Inc. sells franchises to independent operators throughout the northwestern part of the United States. The contract with the franchisee includes the following provisions.
1. The franchisee is charged an initial fee of $120,000. Of this amount, $20,000 is payable when the agreement is signed, and a $20,000 non interest bearing note is payable at the end of each of the 5 subsequent years.
2. All of the initial franchise free collected by Amigos is to be refunded and the remaining obligation canceled if, for any reason, the franchisee fails to open his or her franchise.
3. In return for the initial franchise fee, Amigos agrees to (a) assist the franchisee in selecting the location for the business, (b) negotiate the lease for the land, (c) obtain financing and assist with building design, (d) supervise construction, (e) establish accounting and tax records, and (f) provide expert advice over a 5 year period relating to such matters as employee and management training, quality control, and promotion.
4. In addition to the initial franchise fee, the franchisee is required to pay to Amigos a monthly fee of 2% of sales for menu planning, receipt innovations, and the privilege of purchasing ingredients from Amigos at or below prevailing market prices. Management of Amigos Burrito estimates that the value of the services rendered to the franchisee at the time the contract is signed amounts to at least $20,000. All franchisees to date have opened their locations at the scheduled time, and none have defaulted on any of the notes receivable. The credit ratings of all franchisees would entitle them to borrow at the current interest rate of 10%. The present value of an ordinary annuity of five annual receipts of $20,000 each discounted at 10% is $75,816.
Instructions
(a) Discuss the alternatives that Amigos Burrito Inc. might use to account for the initial franchise fees, evaluate each by applying generally accepted accounting principles, and give illustrative entries for each alternative.
(b) Given the nature of Amigos Burrito’s agreement with its franchisees, when should revenue be recognized? Discuss the question of revenue recognition for both the initial franchise fee and the additional monthly fee of 2% of sales, and give illustrative entries for both types of revenue.
(c) Assume that Amigos Burrito sells some franchises for $100,000, which includes a charge of $20,000 for the rental of equipment for its useful life of 10 years; that $50,000 of the fee is payable immediately and the balance on non interest bearing notes at $10,000 per year; that no portion of the $20,000 rental payment is refundable in case the franchisee goes out of business; and that title to the equipment remains with the franchisor. Under those assumptions, what would be the preferable method of accounting for the rental portion of the initial franchise fee? Explain.
Conlin Corporation had the following tax information.
Year
Taxable Income
Tax Rate
Taxes Paid
2010
$300,000
35%
$105,000
2011
$325,000
30%
$ 97,500
2012
$400,000
30%
$120,000
In 2013, Conlin suffered a net operating loss of $480,000, which it elected to carry back. The 2013 enacted tax rate is 29%. Prepare Conlin’s entry to record the effect of the loss carryback.
(One Temporary Difference, Future Taxable Amounts, One Rate, No Beginning Deferred Taxes) Starfleet Corporation has one temporary difference at the end of 2012 that will reverse and cause taxable amounts of $55,000 in 2013, $60,000 in 2014, and $75,000 in 2015. Starfleet’s pretax financial income for 2012 is $400,000, and the tax rate is 30% for all years. There are no deferred taxes at the beginning of 2012.
Instructions
(a) Compute taxable income and income taxes payable for 2012.
(b) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2012.
(c) Prepare the income tax expense section of the income statement for 2012, beginning with the line “Income before income taxes.”
(Two Differences, No Beginning Deferred Taxes, Tracked through 2 Years) The following information is available for McKee Corporation for 2012.
1. Excess of tax depreciation over book depreciation, $40,000. This $40,000 difference will reverse equally over the years 2013–2016.
2. Deferral, for book purposes, of $25,000 of rent received in advance. The rent will be earned in 2013.
3. Pretax financial income, $350,000.
4. Tax rate for all years, 40%.
Instructions
(a) Compute taxable income for 2012.
(b) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2012.
(c) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2013, assuming taxable income of $325,000.
Patel Company purchased all the outstanding common stock of Singh Company on December 31, 2011. Just before the purchase, the condensed balance sheets of the two companies were as follows.
Patel Company
Singh Company
Current assets
$1,478,000
$379,000
Plant and equipment (net)
1,882,000
351,000
$3,360,000
$730,000
Current liabilities
$ 870,000
$ 90,000
Common stock
1,947,000
360,000
Retained earnings
543,000
280,000
$3,360,000
$730,000
Patel used current assets of $710,000 to acquire the stock of Singh. The excess of this purchase price over the book value of Patel’s net assets is determined to be attributable $20,000 to Singh’s plant and equipment and the remainder to goodwill.
Instructions
(a) Prepare the entry for Patel Company’s acquisition of Singh Company stock.
(b) Prepare a consolidated worksheet at December 31, 2011.
(c) Prepare a consolidated balance sheet at December 31, 2011.
Part I Mindy Feldkamp and her two colleagues, Oscar Lopez and Lori Melton, are personal trainers at an upscale health spa/resort in Tampa, Florida. They want to start a health club that specializes in health plans for people in the 50_ age range.The growing population in this age range and strong consumer interest in the health benefits of physical activity have convinced them they can profitably operate their own club. In addition to many other decisions, they need to determine what type of business organization they want. Oscar believes there are more advantages to the corporate form than a partnership, but he hasn’t yet convinced Mindy and Lori.They have come to you, a small business consulting specialist, seeking information and advice regarding the choice of starting a partnership versus a corporation.
Instructions
(a) Prepare a memo (dated May 26, 2010) that describes the advantages and disadvantages of both partnerships and corporations. Advise Mindy, Oscar, and Lori regarding which organizational form you believe would better serve their purposes. Make sure to include reasons supporting your advice.
After deciding to incorporate, each of the three investors receives 20,000 shares of $2 par common stock on June 12, 2010, in exchange for their co owned building ($200,000 market value) and $100,000 total cash they contributed to the business. The next decision that Mindy, Oscar, and Lori need to make is how to obtain financing for renovation and equipment.They understand the difference between equity securities and debt securities, but do not understand the tax, net income, and earnings per share consequences of equity versus debt financing on the future of their business.
Instructions
(b) Prepare notes for a discussion with the three entrepreneurs in which you will compare the consequences of using equity versus debt financing. As part of your notes, show the differences in interest and tax expense assuming $1,400,000 is financed with common stock, and then alternatively with debt. Assume that when common stock is used, 140,000 shares will be issued.When debt is used, assume the interest rate on debt is 9%, the tax rate is 32%, and income before interest and taxes is $300,000.(You may want to use an electronic spreadsheet.)
During the discussion about financing, Lori mentions that one of her clients, Roberto Marino, has approached her about buying a significant interest in the new club. Having an interested investor sways the three to issue equity securities to provide the financing they need. O July 21, 2010, Mr. Marino buys 90,000 shares at a price of $10 per share. The club, Life Path Fitness, opens on January 12, 2011, and after a slow start, begins to produce the revenue desired by the owners. The owners decide to pay themselves a stock dividend, since cash has been less than abundant since they opened their doors .The 10% stock dividend is declared by the owners on July 27, 2011. The market value of the stock is $3 on the declaration date. The date of record is July 31, 2011 (there have been no changes in stock ownership since the initial issuance), and the issue date is August 15, 2011. By the middle of the fourth quarter of 2011, the cash flow of LifePath Fitness has improved to the point that the owners feel ready to pay themselves a cash dividend. They declare a $0.05 cash dividend on December 4, 2011. The record date is December 14, 2011, and the payment date is December 24, 2011. Instructions (c) (1) Record all of the transactions related to the common stock of LifePath Fitness during the years 2010 and 2011. (2) Indicate how many shares are issued and outstanding after the stock dividend is issued.
Since the club opened, a major concern has been the pool facilities. Although the existing pool is adequate, Mindy, Oscar, and Lori all desire to make Life Path a cutting edge facility. Until the end of 2011, financing concerns prevented this improvement. However, because there has been steady growth in clientele, revenue, and income since the fourth quarter of 2011, the owners have explored possible financing options. They are hesitant to issue stock and change the ownership mix because they have been able to work together as a team with great effectiveness. They have formulated a plan to issue secured term bonds to raise the needed $600,000 for the pool facilities. By the end of April 2012 everything was in place for the bond issue to go ahead. On June 1, 2012, the bonds were issued for $548,000. The bonds pay semiannual interest of 3% (6% annual) on December 1 and June 1 of each year.The bonds mature in 10 years, and amortization is computed using the straight line method.
Instructions
(d) Record (1) the issuance of the secured bonds, (2) the interest payment made on December 1, 2012, (3) the adjusting entry required at December 31, 2012, and (4) the interest payment made on June 1, 2013.
Mr. Marino’s purchase of LifePath Fitness was done through his business. The investment has always been accounted for using the cost method on his firm’s books. However, early in 2013 he decided to take his company public. He is preparing an IPO (initial public offering), and he needs to have the firm’s financial statements audited. One of the issues to be resolved is to restate the investment in LifePath Fitness using the equity method, since Mr. Marino’s ownership percentage is greater than 20%.
Instructions
(e) (1) Give the entries that would have been made on Marino’s books if the equity method of accounting for investments had been used since the initial investment. Assume the following data for LifePath.
2010
2011
2012
Net income
$30,000
$70,000
$105,000
Total cash dividends
$ 2,100
$20,000
$ 50,000
(2) Compute the balance in the LifePath Investment account at the end of 2012.
Most publicly traded companies are analyzed by numerous analysts. These analysts often don’t agree about a company’s future prospects. In this exercise you will find analysts’ ratings about companies and make comparisons over time and across companies in the same industry. You will also see to what extent the analysts experienced “earnings surprises.” Earnings surprises can cause changes in stock prices.
Steps
1. Choose a company.
2. Use the index to find the company’s name.
3. Choose Research.
Instructions
(a) How many analysts rated the company?
(b) What percentage rated it a strong buy?
(c) What was the average rating for the week?
(d) Did the average rating improve or decline relative to the previous week?
(e) How do the analysts rank this company among all the companies in its industry?
(f) What was the amount of the earnings surprise percentage during the last quarter?
At the beginning of the question and answer portion of the annual stockholders’ meeting of Kemper Corporation, stockholder Mike Kerwin asks,“Why did management sell the holdings in UMW Company at a loss when this company has been very profitable during the period its stock was held by Kemper?” Since president Tony Chavez has just concluded his speech on the recent success and bright future of Kemper, he is taken aback by this question and responds, “I remember we paid $1,300,000 for that stock some years ago, and I am sure we sold that stock at a much higher price. You must be mistaken.” Kerwin retorts, “Well, right here in footnote number 7 to the annual report it shows that 240,000 shares, a 30% interest in UMW, were sold on the last day of the year. Also, it states that UMW earned $520,000 this year and paid out $160,000 in cash dividends. Further, a summary statement indicates that in past years, while Kemper held UMW stock, UMW earned $1,240,000 and paid out $440,000 in dividends. Finally, the income statement for this year shows a loss on the sale of UMW stock of $180,000. So, I doubt that I am mistaken.” Red faced, president Chavez turns to you.
Instructions
With the class divided into groups, answer the following.
(a) What dollar amount did Kemper receive upon the sale of the UMW stock?
(b) Explain why both stockholder Kerwin and president Chavez are correct.
Bartlet Financial Services Company holds a large portfolio of debt and stock securities as an investment.The total fair value of the portfolio at December 31, 2011, is greater than total cost. Some securities have increased in value and others have decreased. Deb Faust, the financial vice president, and Jan McCabe, the controller, are in the process of classifying for the first time the securities in the portfolio. Faust suggests classifying the securities that have increased in value as trading securities in order to increase net income for the year. She wants to classify the securities that have decreased in value as long term available for sale securities, so that the decreases in value will not affect 2011 net income. McCabe disagrees. She recommends classifying the securities that have decreased in value as trading securities and those that have increased in value as long term available for sale securities. McCabe argues that the company is having a good earnings year and that recognizing the losses now will help to smooth income for this year. Moreover, for future years, when the company may not be as profitable, the company will have built in gains.
Instructions
(a) Will classifying the securities as Faust and McCabe suggest actually affect earnings as each says it will?
(b) Is there anything unethical in what Faust and McCabe propose? Who are the stakeholders affected by their proposals?
(c) Assume that Faust and McCabe properly classify the portfolio. Assume, at year end, that Faust proposes to sell the securities that will increase 2011 net income, and that McCabe proposes to sell the securities that will decrease 2011 net income. Is this unethical?
Chicago Corporation issued the following statement of cash flows for 2011. Do it!
CHICAGO CORPORATION
Statement of Cash Flows—Indirect Method
For the Year Ended December 31, 2011
Cash flows from operating activities
Net income
$19,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense
$ 8,100
Loss on sale of equipment
1,300
Decrease in accounts receivable
6,900
Increase in inventory
(4,000)
Decrease in accounts payable
(2,000)
10,300
Net cash provided by operating activities
29,300
Cash flows from investing activities
Sale of investments
1,100
Purchase of equipment
(19,000)
Net cash used by investing activities
(17,900)
Cash flows from financing activities
Issuance of stock
10,000
Payment on long term note payable
(5,000)
Payment for dividends
(9,000)
Net cash used by financing activities
(4,000)
Net increase in cash
7,400
Cash at beginning of year
10,000
Cash at end of year
$17,400
(a) Compute free cash flow for Chicago Corporation. (b) Explain why free cash flow often provides better information than “Net cash provided by operating activities.”
The income statement for the year ended December 31, 2011, for Kosinski Manufacturing Company contains the following condensed information.
KOSINSKI MANUFACTURING COMPANY
Income Statement
For the Year Ended December 31, 2011
Revenues
$6,583,000
Operating expenses (excluding depreciation)
$4,920,000
Depreciation expense
880,000
5,800,000
Income before income taxes
783,000
Income tax expense
353,000
Net income
$ 430,000
Included in operating expenses is a $24,000 loss resulting from the sale of machinery for $270,000cash. Machinery was purchased at a cost of $750,000.The following balances are reported on Kosinski’s comparative balance sheets at December 31.
KOSINSKI MANUFACTURING COMPANY
Comparative Balance Sheets (partial)
2011
2010
Cash
$672,000
$130,000
Accounts receivable
775,000
610,000
Inventories
834,000
867,000
Accounts payable
521,000
501,000
Income tax expense of $353,000 represents the amount paid in 2011. Dividends declaredand paid in 2011 totaled $200,000.
Instructions
Prepare the statement of cash flows using the indirect method.
(Recognition of Profit on Long Term Contract) Shanahan Construction Company has entered into a contract beginning January 1, 2012, to build a parking complex. It has been estimated that the complex will cost $600,000 and will take 3 years to construct. The complex will be billed to the purchasing company at $900,000. The following data pertain to the construction period.
2012
2013
2014
Costs to date
$270,000
$450,000
$610,000
Estimated costs to complete
330,000
150,000
–0–
Progress billings to date
270,000
550,000
900,000
Cash collected to date
240,000
500,000
900,000
Instructions
(a) Using the percentage of completion method, compute the estimated gross profit that would be recognized during each year of the construction period.
(b) Using the completed contract method, compute the estimated gross profit that would be recognized during each year of the construction period.
(Recognition of Profit and Entries on Long Term Contract) On March 1, 2012, Chance Company entered into a contract to build an apartment building. It is estimated that the building will cost $2,000,000 and will take 3 years to complete. The contract price was $3,000,000. The following information pertains to the construction period.
2012
2013
2014
Costs to date
$ 600,000
$1,560,000
$2,100,000
Estimated costs to complete
1,400,000
520,000
–0–
Progress billings to date
1,050,000
2,000,000
3,000,000
Cash collected to date
950,000
1,950,000
2,850,000
Instructions
(a) Compute the amount of gross profit to be recognized each year, assuming the percentage of completion method is used.
(b) Prepare all necessary journal entries for 2014.
(c) Prepare a partial balance sheet for December 31, 2013, showing the balances in the receivables and inventory accounts.
(Recognition of Profit and Balance Sheet Presentation, Percentage of Completion) On February 1, 2012, Hewitt Construction Company obtained a contract to build an athletic stadium. The stadium was to be built at a total cost of $5,400,000 and was scheduled for completion by September 1, 2014. One clause of the contract stated that Hewitt was to deduct $15,000 from the $6,600,000 billing price for each week that completion was delayed. Completion was delayed 6 weeks, which resulted in a $90,000 penalty. Below are the data pertaining to the construction period?
2012
2013
2014
Costs to date
$1,620,000
$3,850,000
$5,500,000
Estimated costs to complete
3,780,000
1,650,000
–0–
Progress billings to date
1,200,000
3,300,000
6,510,000
Cash collected to date
1,000,000
2,800,000
6,510,000
Instructions
(a) Using the percentage of completion method, compute the estimated gross profit recognized in the years 2012–2014.
(b) Prepare a partial balance sheet for December 31, 2013, showing the balances in the receivables and inventory accounts.
(Completed Contract and Percentage of Completion with Interim Loss) Reynolds Custom Builders (RCB) was established in 1987 by Avery Conway and initially built high quality customized homes under contract with specific buyers. In the 1990s, Conway’s two sons joined the company and expanded RCB’s activities into the high rise apartment and industrial plant markets. Upon the retirement of RCB’s long time financial manager, Conway’s sons recently hired Ed Borke as controller for RCB. Borke, a former college friend of Conway’s sons, has been associated with a public accounting firm for the last 6 years. Upon reviewing RCB’s accounting practices, Borke observed that RCB followed the completed contract method of revenue recognition, a carryover from the years when individual ho me building was the majority of RCB’s operations. Several years ago, the predominant portion of RCB’s activities shifted to the high rise and industrial building areas. From land acquisition to the completion of construction, most building contracts cover several years. Under the circumstances, Borke believes that RCB should follow the percentage of completion method of accounting. From a typical building contract, Borke developed the following data.
BLUESTEM TRACTOR PLANT
Contract price: $8,000,000
2012
2013
2014
Estimated costs
$1,600,000
$2,880,000
$1,920,000
Progress billings
1,000,000
2,500,000
4,500,000
Cash collections
800,000
2,300,000
4,900,000
Instructions
(a) Explain the difference between completed contract revenue recognition and percentage of completion revenue recognition.
(b) Using the data provided for the Bluestem Tractor Plant and assuming the percentage of completion method of revenue recognition is used, calculate RCB’s revenue and gross profit for 2012, 2013, and 2014, under each of the following circumstances.
(1) Assume that all costs are incurred, all billings to customers are made, and all collections from customers are received within 30 days of billing, as planned.
(2) Further assume that, as a result of unforeseen local ordinances and the fact that the building site was in a wetlands area, RCB experienced cost overruns of $800,000 in 2012 to bring the site into compliance with the ordinances and to overcome wetlands barriers to construction.
(3) Further assume that, in addition to the cost overruns of $800,000 for this contract incurred under part (b)(2), inflationary factors over and above those anticipated in the development of the original contract cost have caused an additional cost overrun of $850,000 in 2013. It is not anticipated that any cost overruns will occur in 2014.
(Long Term Contract with Interim Loss) On March 1, 2012, Pechstein Construction Company contracted to construct a factory building for Fabrik Manufacturing Inc. for a total contract price of $8,400,000. The building was completed by October 31, 2014. The annual contract costs incurred, estimated costs to complete the contract, and accumulated billings to Fabrik for 2012, 2013, and 2014 are given below.
2012
2013
2014
Contract costs incurred during the year
$2,880,000
$2,230,000
$2,190,000
Estimated costs to complete the contract at 12/31
3,520,000
2,190,000
–0–
Billings to Fabrik during the year
3,200,000
3,500,000
1,700,000
Instructions
(a) Using the percentage of completion method, prepare schedules to compute the profit or loss to be recognized as a result of this contract for the years ended December 31, 2012, 2013, and 2014. (Ignore income taxes.)
(b) Using the completed contract method, prepare schedules to compute the profit or loss to be recognized as a result of this contract for the years ended December 31, 2012, 2013, and 2014. (Ignore incomes taxes.)
(Long Term Contract with an Overall Loss) On July 1, 2012, Torvill Construction Company Inc. contracted to build an office building for Gumbel Corp. for a total contract price of $1,900,000. On July 1, Torvill estimated that it would take between 2 and 3 years to complete the building. On December 31, 2014, the building was deemed substantially completed. Following are accumulated contract costs incurred, estimated costs to complete the contract, and accumulated billings to Gumbel for 2012, 2013, and 2014.
At
12/31/12
At
12/31/13
At
12/31/14
Contract costs incurred to date
$ 300,000
$1,200,000
$2,100,000
Estimated costs to complete the contract
1,200,000
800,000
–0–
Billings to Gumbel
300,000
1,100,000
1,850,000
Instructions
(a) Using the percentage of completion method, prepare schedules to compute the profit or loss to be recognized as a result of this contract for the years ended December 31, 2012, 2013, and 2014. (Ignore income taxes.)
(b) Using the completed contract method, prepare schedules to compute the profit or loss to be recognized as a result of this contract for the years ended December 31, 2012, 2013, and 2014. (Ignore income taxes.)
(Installment Sales Computations and Entries) Presented below is summarized information for Johnston Co., which sells merchandise on the installment basis.
2012
2013
2014
Sales (on installment plan)
$250,000
$260,000
$280,000
Cost of sales
155,000
163,800
182,000
Gross profit
$ 95,000
$ 96,200
$ 98,000
Collections from customers on:
2012 installment sales
$75000
$100,000
$ 50,000
2013 installment sales
100,000
120,000
2014 installment sales
100,000
Instructions
(a) Compute the realized gross profit for each of the years 2012, 2013, and 2014.
(b) Prepare in journal form all entries required in 2014, applying the installment sales method of accounting.
Some of Powderhorn Corporation’s investment securities are classified as trading securities and some are classified as available for sale.The cost and market value of each category at December 31, 2011, are shown on the next page.
Cost
Fair Value
Unrealized Gain (Loss)
Trading securities
$93,600
$94,900
$1,300
Available for sale securities
$48,800
$51,400
$2,600
At December 31, 2010, the Market Adjustment—Trading account had a debit balance of $9,200, and the Market Adjustment—Available for Sale account had a credit balance of $5,750. Prepare the required journal entries for each group of securities for December 31, 2011.
Short term debt investments must be readily marketable and expected to be sold within:
a. 3 months from the date of purchase.
b. the next year or operating cycle, whichever is shorter.
c. the next year or operating cycle, whichever is longer.
d. the operating cycle.
Pate Company pays $175,000 for 100% of Sinko’s common stock when Sinko’s stockholders’ equity consists of Common Stock $100,000 and Retained Earnings $60,000. In the worksheet for the consolidated balance sheet, the eliminations will include a:
a. credit to Investment in Sinko Common Stock $160,000.
b. credit to Excess of Book Value over Cost of Subsidiary $15,000.
c. debit to Retained Earnings $75,000.
d. debit to Excess of Cost over Book Value of Subsidiary $15,000.
Presented below and on page 596 are two independent situations:
1. Potomac Inc. acquired 10% of the 500,000 shares of common stock of Maryland Corporation at a total cost of $11 per share on June 17, 2011. On September 3, Maryland declared and paid a $160,000 dividend. On December 31, Maryland reported net income of $550,000 for the year.
2. Andy Fisher Corporation obtained significant influence over Bandit Company by buying 30% of Bandit’s 100,000 outstanding shares of common stock at a cost of $18 per share on
January 1, 2011. On May 15, Bandit declared and paid a cash dividend of $150,000. On
December 31, Bandit reported net income of $270,000 for the year.
Prepare all necessary journal entries for 2011 for (1) Potomac and (2) Andy Fisher.
Some of Grand Junction Corporation’s investment securities are classified as trading securities and some are classified as available for sale. The cost and market value of each category at December 31, 2011, was as follows.
Cost
Fair Value
Unrealized Gain (Loss)
Trading securities
$96,300
$84,900
$(11,400)
Available for sale securities
$59,000
$63,200
$ 4,200
At December 31, 2010, the Market Adjustment—Trading account had a debit balance of $2,200, and the Market Adjustment—Available for Sale account had a credit balance of $7,750. Prepare the required journal entries for each group of securities for December 31, 2011.
1. Heath Cosmetics acquired 15% of the 200,000 shares of common stock of Van Fashion at a total cost of $13 per share on March 18, 2011. On June 30,Van declared and paid a $60,000 dividend. On December 31,Van reported net income of $122,000 for the year. At December 31, the market price of Van Fashion was $15 per share. The stock is classified as availablefor sale.
2. Yoder, Inc., obtained significant influence over Parks Corporation by buying 30% of Parks 30,000 outstanding shares of common stock at a total cost of $9 per share on January 1, 2011. On June 15, Parks declared and paid a cash dividend of $30,000. On December 31, Parks reported a net income of $80,000 for the year.
Instructions
Prepare all the necessary journal entries for 2011 for (1) Heath Cosmetics and (2) Yoder, Inc.
On January 1, 2011, Lennon Corporation acquires 100% of Ono Inc. for $220,000 in cash.The condensed balance sheets of the two corporations immediately following the acquisition are as follows.
Lennon
Ono
Corporation
Inc.
Current assets
$ 60,000
$ 50,000
Investment in Ono Inc. common stock
220,000
Plant and equipment (net)
300,000
220,000
$580,000
$270,000
Current liabilities
$180,000
$ 50,000
Common stock
230,000
80,000
Retained earnings
170,000
140,000
Instructions
Prepare a worksheet for a consolidated balance sheet.
Davison Carecenters Inc. provides financing and capital to the healthcare industry, with a particular focus on nursing homes for the elderly. The following selected transactions relate to bonds acquired as an investment by Davison, whose fiscal year ends on December 31.
2011
Jan. 1 Purchased at face value $2,000,000 of Hannon Nursing Centers, Inc., 10 year, 8% bonds dated January 1, 2011, directly from Hannon.
July 1 Received the semiannual interest on the Hannon bonds.
Dec. 31 Accrual of interest at year end on the Hannon bonds. (Assume that all intervening transactions and adjustments have been properly recorded and that the number of bonds owned has not changed from December 31, 2011, to December 31, 2013.)
2014
Jan. 1 Received the semiannual interest on the Hannon bonds.
Jan. 1 Sold $1,000,000 Hannon bonds at 106. The broker deducted $6,000 for commissions and fees on the sale.
July 1 Received the semiannual interest on the Hannon bonds.
Dec. 31 Accrual of interest at year end on the Hannon bonds.
Instructions
(a) Journalize the listed transactions for the years 2011 and 2014.
(b) Assume that the fair value of the bonds at December 31, 2011, was $2,200,000.These bonds are classified as available for sale securities. Prepare the adjusting entry to record these bonds at fair value.
(c) Based on your analysis in part (b), show the balance sheet presentation of the bonds and interest receivable at December 31, 2011. Assume the investments are considered long term. Indicate where any unrealized gain or loss is reported in the financial statements.
In January 2011, the management of Noble Company concludes that it has sufficient cash to permit some short term investments in debt and stock securities. During the year, the following transactions occurred.
Feb. 1 Purchased 600 shares of Hiens common stock for $31,800, plus brokerage fees of $600.
Mar. 1 Purchased 800 shares of Pryce common stock for $20,000, plus brokerage fees of $400.
Apr. 1 Purchased 50 $1,000, 7% Roy bonds for $50,000, plus $1,000 brokerage fees. Interest is payable semiannually on April 1 and October 1.
July 1 Received a cash dividend of $0.60 per share on the Hiens common stock.
Aug. 1 Sold 200 shares of Hiens common stock at $58 per share less brokerage fees of $200.
Sept. 1 Received a $1 per share cash dividend on the Pryce common stock.
Oct. 1 Received the semiannual interest on the Roy bonds.
Oct. 1 Sold the Roy bonds for $50,000 less $1,000 brokerage fees.
At December 31, the fair value of the Hiens common stock was $55 per share.The fair value of the Pryce common stock was $24 per share.
Instructions
(a) Journalize the transactions shown on page 599 and post to the accounts Debt Investments and Stock Investments. (Use the T account form.)
(b) Prepare the adjusting entry at December 31, 2011, to report the investment securities at fair value. All securities are considered to be trading securities.
(c) Show the balance sheet presentation of investment securities at December 31, 2011.
(d) Identify the income statement accounts and give the statement classification of each account.
On December 31, 2011, Ramey Associates owned the following securities, held as a long term investment. The securities are not held for influence or control of the investee.
Common Stock
Shares
Cost
Hurst Co.
2,000
$60,000
Pine Co.
5,000
45,000
Scott Co.
1,500
30,000
On December 31, 2011, the total fair value of the securities was equal to its cost. In 2012, the following transactions occurred.
July 1 Received $1 per share semiannual cash dividend on Pine Co. common stock.
Aug. 1 Received $0.50 per share cash dividend on Hurst Co. common stock.
Sept. 1 Sold 1,500 shares of Pine Co. common stock for cash at $8 per share, less brokerage fees of $300.
Oct. 1 Sold 800 shares of Hurst Co. common stock for cash at $33 per share, less brokerage fees of $500.
Nov. 1 Received $1 per share cash dividend on Scott Co. common stock.
Dec. 15 Received $0.50 per share cash dividend on Hurst Co. common stock.
31 Received $1 per share semiannual cash dividend on Pine Co. common stock.
At December 31, the fair values per share of the common stocks were: Hurst Co. $32, Pine Co. $8, and Scott Co. $18.
Instructions
(a) Journalize the 2012 transactions and post to the account Stock Investments. (Use the T account form.)
(b) Prepare the adjusting entry at December 31, 2012, to show the securities at fair value. The stock should be classified as available for sale securities.
(c) Show the balance sheet presentation of the investments at December 31, 2012. At this date, Ramey Associates has common stock $1,500,000 and retained earnings $1,000,000.
Glaser Services acquired 30% of the outstanding common stock of Nickels Company on January 1, 2011, by paying $800,000 for the 45,000 shares. Nickels declared and paid $0.30 per share cash dividends on March 15, June 15, September 15, and December 15, 2011. Nickels reported net income of $320,000 for the year. At December 31, 2011, the market price of Nickels common stock was $24 per share.
Instructions
(a) Prepare the journal entries for Glaser Services for 2011 assuming Glaser cannot exercise significant influence over Nickels. (Use the cost method and assume that Nickels common stock should be classified as a trading security.)
(b) Prepare the journal entries for Glaser Services for 2011, assuming Glaser can exercise significant influence over Nickels. Use the equity method.
(c) Indicate the balance sheet and income statement account balances at December 31, 2011, under each method of accounting.
The following securities are in Pascual Company’s portfolio of long term availablefor sale securities at December 31, 2011.
Cost
1,000 shares of Abel Corporation common stock
$52,000
1,400 shares of Frey Corporation common stock
84,000
1,200 shares of Weiss Corporation preferred stock
33,600
On December 31, 2011, the total cost of the portfolio equaled total fair value. Pascual had the following transactions related to the securities during 2012.
Jan. 20 Sold 1,000 shares of Abel Corporation common stock at $55 per share less brokerage fees of $600. 28 Purchased 400 shares of $70 par value common stock of Rosen Corporation at $78 per share, plus brokerage fees of $480. 30 Received a cash dividend of $1.15 per share on Frey Corp. common stock.
Feb. 8 Received cash dividends of $0.40 per share on Weiss Corp. preferred stock. 18 Sold all 1,200 shares of Weiss Corp. preferred stock at $27 per share less brokerage fees of $360.
July 30 Received a cash dividend of $1.00 per share on Frey Corp. common stock.
Sept. 6 Purchased an additional 900 shares of $10 par value common stock of Rosen Corporation at $82 per share, plus brokerage fees of $1,200.
Dec. 1 Received a cash dividend of $1.50 per share on Rosen Corporation common stock.
At December 31, 2012, the fair values of the securities were:
Frey Corporation common stock
$64 per share
Rosen Corporation common stock
$72 per share
Pascual Company uses separate account titles for each investment, such as “Investment in Frey Corporation Common Stock.”
Instructions
(a) Prepare journal entries to record the transactions.
(b) Post to the investment accounts. (Use T accounts.)
(c) Prepare the adjusting entry at December 31, 2012 to report the portfolio at fair value.
(d) Show the balance sheet presentation at December 31, 2012, for the investment related accounts.
Robinson Corporation purchased all the outstanding common stock of Hoffman Plastics, Inc. on December 31, 2011. Just before the purchase, the condensed balance sheets of thetwo companies appeared as follows.
Robinson Corporation
Hoffman Plastics, Inc.
Current assets
$1,480,000
$ 435,500
Plant and equipment (net)
2,100,000
676,000
$3,580,000
$1,111,500
Current liabilities
$ 578,000
$ 92,500
Common stock
1,950,000
525,000
Retained earnings
1,052,000
494,000
$3,580,000
$1,111,500
Robinson used current assets of $1,225,000 to acquire the stock of Hoffman Plastics. The excess of this purchase price over the book value of Hoffman Plastics’ net assets is determined to be attributable $86,000 to Hoffman Plastics’ plant and equipment and the remainder to goodwill.
Instructions
(a) Prepare the entry for Robinson’s acquisition of Hoffman Plastics, Inc. stock.
(b) Prepare a consolidated worksheet at December 31, 2011.
(c) Prepare a consolidated balance sheet at December 31, 2011.
In January 2011, the management of Prasad Company concludes that it has sufficient cash to purchase some short term investments in debt and stock securities. During the year, the following transactions occurred.
Feb. 1 Purchased 500 shares of DET common stock for $30,000, plus brokerage fees of $800.
Mar. 1 Purchased 600 shares of STL common stock for $20,000, plus brokerage fees of $300.
Apr. 1 Purchased 40 $1,000, 9% CIN bonds for $40,000, plus $1,200 brokerage fees. Interest is payable semiannually on April 1 and October 1.
July 1 Received a cash dividend of $0.60 per share on the DET common stock.
Aug. 1 Sold 300 shares of DET common stock at $69 per share, less brokerage fees of $350.
Sept. 1 Received a $1 per share cash dividend on the STL common stock.
Oct. 1 Received the semiannual interest on the CIN bonds.
Oct. 1 Sold the CIN bonds for $45,000, less $1,000 brokerage fees. At December 31, the fair value of the DET common stock was $66 per share. The fair value of the STL common stock was $29 per share.
Instructions
(a) Journalize the transactions and post to the accounts Debt Investments and Stock Investments. (Use the T account form.)
(b) Prepare the adjusting entry at December 31, 2011, to report the investments at fair value. All securities are considered to be trading securities.
(c) Show the balance sheet presentation of investment securities at December 31, 2011.
(d) Identify the income statement accounts and give the statement classification of each account.
On December 31, 2011, Sauder Associates owned the following securities, held as long term investments.
Common Stock
Shares
Cost
Adel Co.
4,000
$100,000
Beran Co.
5,000
30,000
Caren Co.
3,000
60,000
On this date, the total fair value of the securities was equal to its cost.The securities are not held for influence or control over the investees. In 2012, the following transactions occurred.
July 1 Received $1 per share semiannual cash dividend on Beran Co. common stock.
Aug. 1 Received $0.50 per share cash dividend on Adel Co. common stock.
Sept. 1 Sold 1,500 shares of Beran Co. common stock for cash at $8 per share, less brokerage fees of $300.
Oct. 1 Sold 600 shares of Adel Co. common stock for cash at $30 per share, less brokerage fees of $600.
Nov. 1 Received $1 per share cash dividend on Caren Co. common stock.
Dec. 15 Received $0.50 per share cash dividend on Adel Co. common stock.
31 Received $1 per share semiannual cash dividend on Beran Co. common stock.
At December 31, the fair values per share of the common stocks were: Adel Co. $23, Beran Co. $7, and Caren Co. $19.
Instructions
(a) Journalize the 2012 transactions and post to the account Stock Investments. (Use the T account form.)
(b) Prepare the adjusting entry at December 31, 2012, to show the securities at fair value. The stock should be classified as available for sale securities.
(c) Show the balance sheet presentation of the investment related accounts at December 31, 2012. At this date, Sauder Associates has common stock $2,000,000 and retained earnings $1,200,000.
Terry’s Concrete acquired 20% of the outstanding common stock of Blakeley, Inc. on January 1, 2011, by paying $1,100,000 for 40,000 shares. Blakeley declared and paid a $0.50 per share cash dividend on June 30 and again on December 31, 2011. Blakeley reported net income of $600,000 for the year.At December 31, 2011, the market price of Blakeley’s common stock was $30 per share.
Instructions
(a) Prepare the journal entries for Terry’s Concrete for 2011 assuming Terry’s cannot exercise significant influence over Blakeley. (Use the cost method and assume Blakeley common stock should be classified as available for sale.)
(b) Prepare the journal entries for Terry’s Concrete for 2011, assuming Terry’s can exercise significant influence over Blakeley. (Use the equity method.)
(c) Indicate the balance sheet and income statement account balances at December 31, 2011, under each method of accounting.
Hayslett Corporation was organized on January 1, 2011. It is authorized to issue 20,000 shares of 6%, $50 par value preferred stock, and 500,000 shares of no par common stock with a stated value of $2 per share.The following stock transactions were completed during the first year.
Jan. 10 Issued 100,000 shares of common stock for cash at $3 per share.
Mar. 1 Issued 10,000 shares of preferred stock for cash at $55 per share.
Apr. 1 Issued 25,000 shares of common stock for land. The asking price of the land was $90,000.The company’s estimate of the fair market value of the land was $85,000.
May 1 Issued 75,000 shares of common stock for cash at $4 per share.
Aug. 1 Issued 10,000 shares of common stock to attorneys in payment of their bill for $50,000 for services provided in helping the company organize.
Sept. 1 Issued 5,000 shares of common stock for cash at $6 per share.
Nov. 1 Issued 2,000 shares of preferred stock for cash at $58 per share.
Instructions
(a) Journalize the transactions.
(b) Post to the stockholders’ equity accounts. (Use J1 as the posting reference.)
(c) Prepare the paid in capital section of stockholders’ equity at December 31, 2011.
Greeve Corporation had the following stockholders’ equity accounts on January 1, 2011: Common Stock ($1 par) $400,000, Paid in Capital in Excess of Par Value $500,000, and Retained Earnings $100,000. In 2011, the company had the following treasury stock transactions.
Mar. 1 Purchased 5,000 shares at $7 per share.
June 1 Sold 1,000 shares at $10 per share.
Sept. 1 Sold 2,000 shares at $9 per share.
Dec. 1 Sold 1,000 shares at $5 per share.
Greeve Corporation uses the cost method of accounting for treasury stock. In 2011, the company reported net income of $60,000.
Instructions
(a) Journalize the treasury stock transactions, and prepare the closing entry at December 31, 2011, for net income.
(b) Open accounts for (1) Paid in Capital from Treasury Stock, (2) Treasury Stock, and
(3) Retained Earnings. Post to these accounts using J12 as the posting reference.
(c) Prepare the stockholders’ equity section for Greeve Corporation at December 31, 2011.
The stockholders’ equity accounts of Jajoo Corporation on January 1, 2011, were as follows.
Preferred Stock (10%, $100 par noncumulative, 5,000 shares authorized)
$ 300,000
Common Stock ($5 stated value, 300,000 shares authorized)
1,000,000
Paid in Capital in Excess of Par Value—Preferred Stock
20,000
Paid in Capital in Excess of Stated Value—Common Stock
425,000
Retained Earnings
488,000
Treasury Stock—Common (5,000 shares)
40,000
During 2011, the corporation had the following transactions and events pertaining to its stockholders’ equity.
Feb. 1 Issued 3,000 shares of common stock for $25,000.
Mar. 20 Purchased 1,500 additional shares of common treasury stock at $8 per share.
June 14 Sold 4,000 shares of treasury stock—common for $36,000.
Sept. 3 Issued 2,000 shares of common stock for a patent valued at $17,000.
Dec. 31 Determined that net income for the year was $340,000.
Instructions
(a) Journalize the transactions and the closing entry for net income. (b) Enter the beginning balances in the accounts and post the journal entries to the stockholders’
equity accounts. (Use J1 as the posting reference.)
(c) Prepare a stockholders’ equity section at December 31, 2011.
On January 1, 2011, Galactica Corporation had the following stockholders’ equity accounts.
Feb. 1 Issued 3,000 shares issued and of common stock for $25,000.
$1,200,000
Mar. 20 Purchased 1,500 additional shares of common treasury stock at $8 per share.
200,000
June 14 Sold 4,000 shares of treasury stock—common for $36,000.
500,000
During the year, the following transactions occurred.
Feb. 1 Declared a $1 cash dividend per share to stockholders of record on February 15, payable March 1.
Mar. 1 Paid the dividend declared in February.
Apr. 1 Announced a 5 for 1 stock split. Prior to the split, the market price per share was $35.
July 1 Declared a 5% stock dividend to stockholders of record on July 15, distributable July
31. On July 1, the market price of the stock was $7 per share.
July 31 Issued the shares for the stock dividend.
Dec. 1 Declared a $0.50 per share dividend to stockholders of record on December 15, payable January 5, 2012.
31 Determined that net income for the year was $380,000.
Instructions
(a) Journalize the transactions and closing entries.
(b) Enter the beginning balances and post the entries to the stockholders’ equity accounts. (Note: Open additional stockholders’ equity accounts as needed.)
(c) Prepare a stockholders’ equity section at December 31.
The ledger of Nakona Corporation at December 31, 2011, after the books have been closed, contains the following stockholders’ equity accounts.
Preferred Stock (10,000 shares issued)
$1,000,000
Common Stock (400,000 shares issued)
2,000,000
Paid in Capital in Excess of Par Value—Preferred
200,000
Paid in Capital in Excess of Stated Value—Common
1,100,000
Common Stock Dividends Distributable
200,000
Retained Earnings
2,365,000
A review of the accounting records reveals the following.
1. No errors have been made in recording 2011 transactions or in preparing the closing entry for net income.
2. Preferred stock is 8%, $100 par value, noncumulative, and callable at $125. Since January 1, 2010, 10,000 shares have been outstanding; 20,000 shares are authorized.
3. Common stock is no par with a stated value of $5 per share; 600,000 shares are authorized.
4. The January 1 balance in Retained Earnings was $2,450,000.
5. On October 1, 100,000 shares of common stock were sold for cash at $8 per share.
6. A cash dividend of $600,000 was declared and properly allocated to preferred and common stock on November 1. No dividends were paid to preferred stockholders in 2010.
7. On December 31, a 10% common stock dividend was declared out of retained earnings on common stock when the market price per share was $7.
8. Net income for the year was $795,000.
9. On December 31, 2011, the directors authorized disclosure of a $100,000 restriction of retained earnings for plant expansion. (Use Note A.)
Instructions
(a) Reproduce the Retained Earnings account (T account) for the year.
(b) Prepare a retained earnings statement for the year.
(c) Prepare a stockholders’ equity section at December 31.
(d) Compute the earnings per share of common stock using 325,000 as the weighted average shares outstanding for the year.
(e) Compute the allocation of the cash dividend to preferred and common stock.
Arnold Corporation has been authorized to issue 40,000 shares of $100 par value, 8%, noncumulative preferred stock and 2,000,000 shares of no par common stock. The corporation assigned a $5 stated value to the common stock. At December 31, 2011, the ledger contained the following balances pertaining to stockholders’ equity.
Preferred Stock
$ 240,000
Paid in Capital in Excess of Par Value—Preferred
56,000
Common Stock
2,000,000
Paid in Capital in Excess of Stated Value—Common
5,700,000
Treasury Stock—Common (1,000 shares)
22,000
Paid in Capital from Treasury Stock
3,000
Retained Earnings
560,000
The preferred stock was issued for land having a fair market value of $296,000.All common stock issued was for cash. In November, 1,500 shares of common stock were purchased for the treasury at a per share cost of $22. In December, 500 shares of treasury stock were sold for $28 per share. No dividends were declared in 2011.
Instructions
(a) Prepare the journal entries for the:
(1) Issuance of preferred stock for land.
(2) Issuance of common stock for cash.
(3) Purchase of common treasury stock for cash.
(4) Sale of treasury stock for cash.
(b) Prepare the stockholders’ equity section at December 31, 2011.
On January 1, 2011, Snider Corporation had the following stockholders’ equity accounts.
Common Stock ($10 par value, 90,000 shares issued and outstanding)
$900,000
Paid in Capital in Excess of Par Value
200,000
Retained Earnings
540,000
During the year, the following transactions occurred.
Jan. 15 Declared a $1 cash dividend per share to stockholders of record on January 31, payable February 15.
Feb. 15 Paid the dividend declared in January.
Apr. 15 Declared a 10% stock dividend to stockholders of record on April 30, distributable
May 15. On April 15, the market price of the stock was $15 per share.
May 15 Issued the shares for the stock dividend.
July 1 Announced a 2 for 1 stock split.The market price per share prior to the announcement was $17. (The new par value is $5.)
Dec. 1 Declared a $0.50 per share cash dividend to stockholders of record on December 15, payable January 10, 2012.
31 Determined that net income for the year was $250,000.
Instructions
(a) Journalize the transactions and the closing entries for net income and dividends.
(b) Enter the beginning balances, and post the entries to the stockholders’ equity accounts. (Note: Open additional stockholders’ equity accounts as needed.)
(c) Prepare a stockholders’ equity section at December 31.
Keeler Corporation was organized on January 1, 2011. It is authorized to issue 10,000 shares of 8%, $100 par value preferred stock, and 500,000 shares of no par common stock with a stated value of $3 per share.The following stock transactions were completed during the first year.
Jan. 10 Issued 80,000 shares of common stock for cash at $4 per share.
Mar. 1 Issued 5,000 shares of preferred stock for cash at $105 per share.
Apr. 1 Issued 24,000 shares of common stock for land. The asking price of the land was $90,000.The fair market value of the land was $85,000.
May 1 Issued 80,000 shares of common stock for cash at $4.50 per share.
Aug. 1 Issued 10,000 shares of common stock to attorneys in payment of their bill of $40,000 for services provided in helping the company organize.
Sept. 1 Issued 10,000 shares of common stock for cash at $5 per share.
Nov. 1 Issued 1,000 shares of preferred stock for cash at $109 per share.
Instructions
(a) Journalize the transactions.
(b) Post to the stockholders’ equity accounts. (Use J5 as the posting reference.)
(c) Prepare the paid in capital section of stockholders’ equity at December 31, 2011.
The stockholders’ equity accounts of Port Corporation on January 1, 2011, were as follows.
Preferred Stock (8%, $50 par cumulative, 10,000 shares authorized)
$ 400,000
Common Stock ($1 stated value, 2,000,000 shares authorized)
1,000,000
Paid in Capital in Excess of Par Value—Preferred Stock
100,000
Paid in Capital in Excess of Stated Value—Common Stock
1,450,000
Retained Earnings
1,816,000
Treasury Stock—Common (10,000 shares)
40,000
During 2011, the corporation had the following transactions and events pertaining to its stockholders’
equity. Feb. 1 Issued 25,000 shares of common stock for $100,000.
Apr. 14 Sold 6,000 shares of treasury stock—common for $33,000.
Sept. 3 Issued 5,000 shares of common stock for a patent valued at $30,000.
Nov. 10 Purchased 1,000 shares of common stock for the treasury at a cost of $6,000.
Dec. 31 Determined that net income for the year was $452,000. No dividends were declared during the year.
Instructions
(a) Journalize the transactions and the closing entry for net income.
(b) Enter the beginning balances in the accounts, and post the journal entries to the stock holders’ equity accounts. (Use J5 for the posting reference.)
(c) Prepare a stockholders’ equity section at December 31, 2011, including the disclosure of the preferred dividends in arrears.
On January 1, 2011, Argentina Corporation had the following stockholders’ equity accounts.
Common Stock ($20 par value, 75,000 shares issued and outstanding)
$1,500,000
Paid in Capital in Excess of Par Value
200,000
Retained Earnings
600,000
During the year, the following transactions occurred.
Feb. 1 Declared a $1 cash dividend per share to stockholders of record on February 15, payable March 1.
Mar. 1 Paid the dividend declared in February.
Apr. 1 Announced a 2 for 1 stock split. Prior to the split, the market price per share was $36.
July 1 Declared a 10% stock dividend to stockholders of record on July 15, distributable
July 31. On July 1, the market price of the stock was $13 per share.
31 Issued the shares for the stock dividend.
Dec. 1 Declared a $0.50 per share dividend to stockholders of record on December 15, payable January 5, 2012.
31 Determined that net income for the year was $350,000.
Instructions
(a) Journalize the transactions and the closing entries for net income and dividends.
(b) Enter the beginning balances, and post the entries to the stockholders’ equity accounts. (Note: Open additional stockholders’ equity accounts as needed.)
(c) Prepare a stockholders’ equity section at December 31.
On December 31, 2010, Bradstrom Company had 1,500,000 shares of $10 par common stock issued and outstanding. The stockholders’ equity accounts at December 31, 2010, had the following balances.
Common Stock
$15,000,000
Additional Paid in Capital
1,500,000
Retained Earnings
900,000
Transactions during 2011 and other information related to stockholders’ equity accounts were as follows.
1. On January 10, 2011, Bradstrom issued at $105 per share 100,000 shares of $100 par value,7% cumulative preferred stock.
2. On February 8, 2011, Bradstrom reacquired 15,000 shares of its common stock for $16 per share.
3. On June 8, 2011, Bradstrom declared a cash dividend of $1 per share on the common stock outstanding, payable on July 10, 2011, to stockholders of record on July 1, 2011.
4. On December 15, 2011, Bradstrom declared the yearly cash dividend on preferred stock, payable January 10, 2012, to stockholders of record on December 15, 2011.
5. Net income for the year is $3,600,000.
6. It was discovered that depreciation expense had been overstated in 2010 by $80,000.
Instructions
(a) Prepare a retained earnings statement for the year ended December 31, 2011.
(b) Prepare the stockholders’ equity section of Bradstrom’s balance sheet at December 31, 2011.
The post closing trial balance of Chen Corporation at December 31, 2011, contains the following stockholders’ equity accounts.
Preferred Stock (15,000 shares issued)
$ 750,000
Common Stock (250,000 shares issued)
2,500,000
Paid in Capital in Excess of Par Value—Preferred
250,000
Paid in Capital in Excess of Par Value—Common
400,000
Common Stock Dividends Distributable
250,000
Retained Earnings
902,000
A review of the accounting records reveals the following.
1. No errors have been made in recording 2011 transactions or in preparing the closing entry for net income.
2. Preferred stock is $50 par, 8%, and cumulative; 15,000 shares have been outstanding since January 1, 2010.
3. Authorized stock is 20,000 shares of preferred, 500,000 shares of common with a $10 par
value. 4. The January 1 balance in Retained Earnings was $1,170,000.
5. On July 1, 20,000 shares of common stock were sold for cash at $16 per share.
6. On September 1, the company discovered an understatement error of $90,000 in computing depreciation in 2010. The net of tax effect of $63,000 was properly debited directly to Retained Earnings. 7. A cash dividend of $250,000 was declared and properly allocated to preferred and common stock on October 1. No dividends were paid to preferred stockholders in 2010.
8. On December 31, a 10% common stock dividend was declared out of retained earnings on common stock when the market price per share was $18.
9. Net income for the year was $495,000.
10. On December 31, 2011, the directors authorized disclosure of a $200,000 restriction of retained earnings for plant expansion. (Use Note X.)
Instructions
(a) Reproduce the Retained Earnings account for the year.
(b) Prepare a retained earnings statement for the year.
(c) Prepare a stockholders’ equity section at December 31.
(d) Compute the earnings per share of common stock using 240,000 as the weighted average shares outstanding for the year.
(e) Compute the allocation of the cash dividend to preferred and common stock.
PepsiCo’s financial statements are presented in Appendix A. Coca Cola’s financial statements are presented in Appendix B.
Instructions
(a) Based on the information contained in these financial statements, compute the 2008 book value per share for each company. (Hint: Use the value reported for “common shareholders’ equity” as the numerator for PepsiCo.) (b) Compare the market value per share for each company to the book value per share at yearend 2008. Assume that the market value of Coca Cola’s stock was $45.27 at year end 2008.
(c) Why are book value and market value per share different?
(d) Compute earnings per share and return on common stockholders’ equity for both companies for the year ending in January 2008. Assume PepsiCo’s weighted average shares were 1,575 million and Coca Cola’s weighted average shares were 2,462 million. Can these measures be used to compare the profitability of the two companies? Why or why not?
(e) What was the total amount of dividends paid by each company in 2008?
The stockholders’ meeting for Harris Corporation has been in progress for some time. The chief financial officer for Harris is presently reviewing the company’s financial statements and is explaining the items that comprise the stockholders’ equity section of the balance sheet for the current year.The stockholders’ equity section of Harris Corporation at December 31, 2011, is shown on page 565.
HARRIS CORPORATION
Balance Sheet (partial)
December 31, 2011
Paid in capital
Capital stock
Preferred stock, authorized 1,000,000 shares
cumulative, $100 par value, $8 per share, 6,000
shares issued and outstanding
$ 600,000
Common stock, authorized 5,000,000 shares, $1 par
value, 3,000,000 shares issued, and 2,700,000
outstanding
3,000,000
Total capital stock
3,600,000
Additional paid in capital
In excess of par value—preferred stock
$ 50,000
In excess of par value—common stock
25,000,000
Total additional paid in capital
25,050,000
Total paid in capital
28,650,000
Retained earnings
900,000
Total paid in capital and retained earnings
29,550,000
Less: Common treasury stock (300,000 shares)
9,300,000
Total stockholders’ equity
$20,250,000
At the meeting, stockholders have raised a number of questions regarding the stockholders’ equity section.
Instructions
With the class divided into groups, answer the following questions as if you were the chief financial officer for Harris Corporation.
(a) “What does the cumulative provision related to the preferred stock mean?”
(b) “I thought the common stock was presently selling at $29.75, but the company has the stock stated at $1 per share. How can that be?”
(c) “Why is the company buying back its common stock? Furthermore, the treasury stock has a debit balance because it is subtracted from stockholders’ equity .Why is treasury stock not reported as an asset if it has a debit balance?”
(d) Why is it necessary to show additional paid in capital? Why not just show common stock at the total amount paid in?”
The R&D division of Healy Chemical Corp. has just developed a chemical for sterilizing the vicious Brazilian “killer bees” which are invading Mexico and the southern states of the United States. The president of Healy is anxious to get the chemical on the market to boost Healy’s profits. He believes his job is in jeopardy because of decreasing sales and profits. Healy has an opportunity to sell this chemical in Central American countries, where the laws are much more relaxed than in the United States. The director of Healy’s R&D division strongly recommends further testing in the laboratory for side effects of this chemical on other insects, birds, animals, plants, and even humans. He cautions the president, “We could be sued from all sides if the chemical has tragic side effects that we didn’t even test for in the labs.” The president answers, “We can’t wait an additional year for your lab tests.We can avoid losses from such lawsuits by establishing a separate wholly owned corporation to shield Healy Corp. from such lawsuits.We can’t lose any more than our investment in the new corporation, and we’ll invest just the patent covering this chemical. We’ll reap the benefits if the chemical works and is safe, and avoid the losses from lawsuits if it’s a disaster.” The following week Healy creates a new wholly owned corporation called Dryden Inc., sells the chemical patent to it for $10, and watches the spraying begin.
Instructions
(a) Who are the stakeholders in this situation?
(b) Are the president’s motives and actions ethical?
(c) Can Healy shield itself against losses of Dryden Inc.?
A high percentage of Americans own stock in corporations. As a shareholder in a corporation, you will receive an annual report. One of the goals of this course is for you to learn how to navigate your way around an annual report.
Instructions
Use the annual report provided in Appendix A to answer the following questions.
(a) What CPA firm performed the audit of PepsiCo’s financial statements?
(b) What was the amount of PepsiCo’s basic earnings per share in 2008?
(c) What were net sales in 2008?
(d) How many shares of treasury stock did the company have at the end of 2008?
(e) How much cash did PepsiCo spend on capital expenditures in 2008?
(f) Over what life does the company depreciate its buildings?
(g) What was the total amount of dividends paid in 2008?
The budget committee of Earnhart Company collects the following data for its Del Fuego Store in preparing budgeted income statements for May and June 2013.
1. Sales for May are expected to be $800,000. Sales in June and July are expected to be 10% higher than the preceding month.
2. Cost of goods sold is expected to be 75% of sales.
3. Company policy is to maintain ending merchandise inventory at 20% of the following month’s cost of goods sold.
4. Operating expenses are estimated to be:
Sales salaries
$30,000 per month
Advertising
5% of monthly sales
Delivery expense
3% of monthly sales
Sales commissions
4% of monthly sales
Rent expense
$5,000 per month
Depreciation
$800 per month
Utilities
$600 per month
Insurance
$500 per month
5. Income taxes are estimated to be 30% of income from operations.
Instructions
(a) Prepare the merchandise purchases budget for each month in columnar form.
(b) Prepare budgeted income statements for each month in columnar form. Show in the statements the details of cost of goods sold.
Putin Industries’ balance sheet at December 31, 2012, is presented below.
PUTIN INDUSTRIES
Balance Sheet
December 31, 2012
Assets
Current assets
$ 7,500
Cash
82,500
Accounts receivable
30,000
Finished goods inventory (2,000 units)
120,000
Total current assets
Property, plant, and equipment
$40,000
Equipment
10,000
30,000
Less: Accumulated depreciation—equip.
$150,000
Total assets
Common stock
Retained earnings
Total liabilities and stockholders’ equity
Liabilities and Stockholders’ Equity
Liabilities
Notes payable
$ 25,000
Accounts payable
45,000
Total liabilities
70,000
Stockholders’ equity
Common stock
$50,000
Retained earnings
30,000
Total stockholders’ equity
80,000
Total liabilities and stockholders’ equity
$150,000
Additional information accumulated for the budgeting process is as follows.
Budgeted data for the year 2013 include the following.
Year
4th Qtr.
2013
of 2013
Total
Sales budget (8,000 units at $35)
$84,000
$280,000
Direct materials used
17,000
69,400
Direct labor
12,500
56,600
Manufacturing overhead applied
10,000
54,000
Selling and administrative expenses
18,000
76,000
To meet sales requirements and to have 3,000 units of finished goods on hand at December 31, 2013, the production budget shows 9,000 required units of output. The total unit cost of production is expected to be $20. Putin Industries uses the first in, first out (FIFO) inventory costing method. Selling and administrative expenses include $4,000 for depreciation on equipment. Interest expense is expected to be $3,500 for the year. Income taxes are expected to be 30% of income before income taxes.
All sales and purchases are on account. It is expected that 60% of quarterly sales are collected in cash within the quarter and the remainder is collected in the following quarter. Direct materials purchased from suppliers are paid 50% in the quarter incurred and the remainder in the following quarter. Purchases in the fourth quarter were the same as the materials used. In 2013, the company expects to purchase additional equipment costing $19,000. It expects to pay $8,000 on notes payable plus all interest due and payable to December 31 (included in interest expense $3,500, above). Accounts payable at December 31, 2013, includes amounts due suppliers (see above) plus other accounts payable of $5,700. In 2013, the company expects to declare and pay a $5,000 cash dividend. Unpaid income taxes at December 31 will be $5,000. The company’s cash budget shows an expected cash balance of $7,950 at December 31, 2013.
Instructions
Prepare a budgeted income statement for 2013 and a budgeted balance sheet at December 31, 2013. In preparing the income statement, you will need to compute cost of goods manufactured (direct materials + direct labor + manufacturing overhead) and finished goods inventory (December 31, 2013).
Myagi Farm Supply Company manufactures and sells a fertilizer called Basic II. The following data are available for preparing budgets for Basic II for the first 2 quarters of 2012.
1. Sales: Quarter 1, 40,000 bags; quarter 2, 50,000 bags. Selling price is $65 per bag.
2. Direct materials: Each bag of Basic II requires 6 pounds of Crup at a cost of $4 per pound and 10 pounds of Dert at $1.50 per pound.
3. Desired inventory levels:
Type of Inventory
January 1
April 1
July 1
Basic II (bags)
10,000
15,000
20,000
Crup (pounds)
9,000
12,000
15,000
Dert (pounds)
15,000
20,000
25,000
4. Direct labor: Direct labor time is 15 minutes per bag at an hourly rate of $10 per hour.
5. Selling and administrative expenses are expected to be 10% of sales plus $160,000 per quarter.
6. Income taxes are expected to be 30% of income from operations.
Your assistant has prepared two budgets: (1) The manufacturing overhead budget shows expected costs to be 100% of direct labor cost. (2) The direct materials budget for Dert which shows the cost of Dert to be $682,500 in quarter 1 and $825,00 in quarter 2.
Instructions
Prepare the budgeted income statement for the first 6 months of 2012 and all required supporting budgets by quarters. (Note: Use variable and fixed in the selling and administrative expense budget.)
Do not prepare the manufacturing overhead budget or the direct materials budget for Dert.
Raleigh Inc. is preparing its annual budgets for the year ending December 31, 2012. Accounting assistants furnish the following data.
Product
Product
LN 35
LN 40
Sales budget:
Anticipated volume in units
400,000
240,000
Unit selling price
$25
$35
Production budget:
Desired ending finished goods units
30,000
25,000
Beginning finished goods units
20,000
15,000
Direct materials budget:
Direct materials per unit (pounds)
2
3
Desired ending direct materials pounds
50,000
20,000
Beginning direct materials pounds
40,000
10,000
Cost per pound
$2
$3
Direct labor budget:
Direct labor time per unit
0.5
0.75
Direct labor rate per hour
$12
$12
Budgeted income statement:
Total unit cost
$11
$20
An accounting assistant has prepared the detailed manufacturing overhead budget and the selling and administrative expense budget. The latter shows selling expenses of $750,000 for product LN 35 and $590,000 for product LN 40, and administrative expenses of $420,000 for product LN 35 and $380,000 for product LN 40. Income taxes are expected to be 30%.
Instructions
Prepare the following budgets for the year. Show data for each product. You do not need to prepare quarterly budgets.
(a) Sales
(b) Production
(c) Direct materials
(d) Direct labor
(e) Income statement (Note: Income taxes are not allocated to the products.)
Mintz Industries has sales in 2012 of $5,600,000 (800,000 units) and gross profit of $1,344,000. Management is considering two alternative budget plans to increase its gross profit in 2013.
Plan A would increase the selling price per unit from $7.00 to $7.60. Sales volume would decrease by 10% from its 2012 level. Plan B would decrease the selling price per unit by 5%. The marketing department expects that the sales volume would increase by 100,000 units.
At the end of 2012, Mintz has 70,000 units on hand. If Plan A is accepted, the 2013 ending inventory should be equal to 90,000 units. If Plan B is accepted, the ending inventory should be equal to 100,000 units. Each unit produced will cost $2.00 in direct materials, $1.50 in direct labor, and $0.50 in variable overhead. The fixed overhead for 2013 should be $925,000.
Instructions
(a) Prepare a sales budget for 2013 under (1) Plan A and (2) Plan B.
(b) Prepare a production budget for 2013 under (1) Plan A and (2) Plan B.
(c) Compute the cost per unit under (1) Plan A and (2) Plan B. Explain why the cost per unit is different for each of the two plans. (Round to two decimals.)
(d) Which plan should be accepted? (Hint: Compute the gross profit under each plan.)
Weiss Company prepares monthly cash budgets. Relevant data from operating budgets for 2013 are:
January
February
Sales
$350,000
$400,000
Direct materials purchases
120,000
110,000
Direct labor
85,000
115,000
Manufacturing overhead
60,000
75,000
Selling and administrative expenses
75,000
80,000
All sales are on account. Collections are expected to be 60% in the month of sale, 30% in the first month following the sale, and 10% in the second month following the sale. Thirty percent (30%) of direct materials purchases are paid in cash in the month of purchase, and the balance due is paid in the month following the purchase. All other items above are paid in the month incurred. Depreciation has been excluded from manufacturing overhead and selling and administrative expenses.
Other data:
1. Credit sales: November 2012, $200,000; December 2012, $280,000.
2. Purchases of direct materials: December 2012, $90,000.
3. Other receipts: January—Collection of December 31, 2012, interest receivable $3,000; February—Proceeds from sale of securities $5,000.
4. Other disbursements: February—payment of $20,000 for land.
The company’s cash balance on January 1, 2013, is expected to be $50,000. The company wants to maintain a minimum cash balance of $40,000.
Instructions
(a) Prepare schedules for (1) expected collections from customers and (2) expected payments for direct materials purchases.
(b) Prepare a cash budget for January and February in columnar form.
Bryant Corporation operates on a calendar year basis. It begins the annual bud geting processing late August when the president establishes targets for the total dollar sales and net income before taxes for the next year.
The sales target is given first to the marketing department. The marketing manager formulates a sales budget by product line in both units and dollars. From this budget, sales quotas by product line in units and dollars are established for each of the corporation’s sales districts. The marketing manager also estimates the cost of the marketing activities required to support the target sales volume and prepares a tentative marketing expense budget.
The executive vice president uses the sales and profit targets, the sales budget by product line, and the tentative marketing expense budget to determine the dollar amounts that can be devoted to manufacturing and corporate office expense. The executive vice president prepares the budget for corporate expenses. She then forwards to the production department the product line sales budget in units and the total dollar amount that can be devoted to manufacturing.
The production manager meets with the factory managers to develop a manufacturing plan that will produce the required units when needed within the cost constraints set by the executive vice president. The budgeting process usually comes to a halt at this point because the production department does not consider the financial resources allocated to be adequate.
When this standstill occurs, the vice president of finance, the executive vice president, the marketing manager, and the production manager meet together to determine the final budgets for each of the areas. This normally results in a modest increase in the total amount available for manufacturing costs and cuts in the marketing expense and corporate office expense bud gets. The total sales and net income figures proposed by the president are seldom changed. Although the participants are seldom pleased with the compromise, these budgets are final. Each executive then develops a new detailed budget for the operations in his or her area.
None of the areas has achieved its budget in recent years. Sales often run below the target. When budgeted sales are not achieved, each area is expected to cut costs so that the president’s profit target can be met. However, the profit target is seldom met because costs are not cut enough. In fact, costs often run above the original budget in all functional areas (marketing, production, and corporate office).
The president is disturbed that Bryant has not been able to meet the sales and profit targets. He hired a consultant with considerable experience with companies in Bryant’s industry. The consultant reviewed the budgets for the past 4 years. He concluded that the product line sales budgets were reasonable and that the cost and expense budgets were adequate for the budgeted sales and production levels.
Instructions
With the class divided into groups, answer the following.
(a) Discuss how the budgeting process employed by Bryant Corporation contributes to the failure to achieve the president’s sales and profit targets.
(b) Suggest how Bryant Corporation’s budgeting process could be revised to correct the problems.
(c) Should the functional areas be expected to cut their costs when sales volume falls below budget? Explain your answer.
Blog & Twitter Inc. manufactures ergonomic devices for computer users. Some of their more popular products include glare screens (for computer monitors), keyboard stands with wrist rests, and carousels that allow easy access to magnetic disks. Over the past 5 years, it experienced rapid growth, with sales of all products increasing 20% to 50% each year.
Last year, some of the primary manufacturers of computers began introducing new products with some of the ergonomic designs, such as glare screens and wrist rests, already built in. As a result, sales of Blog & Twitter’s accessory devices have declined somewhat. The company believes that the disk carousels will probably continue to show growth, but that the other products will probably continue to decline. When the next year’s budget was prepared, increases were built in to research and development so that replacement products could be developed or the company could expand into some other product line. Some product lines being considered are general purpose ergonomic devices including back supports, foot rests, and sloped writing pads.
The most recent results have shown that sales decreased more than was expected for the glare screens. As a result, the company may have a shortage of funds. Top management has therefore asked that all expenses be reduced 10% to compensate for these reduced sales. Summary budget information is as follows.
Direct materials
$240,000
Direct labor
110,000
Insurance
50,000
Depreciation
90,000
Machine repairs
30,000
Sales salaries
50,000
Office salaries
80,000
Factory salaries (indirect labor)
50,000
Total
$700,000
Instructions
Using the information above, answer the following questions.
(a) What are the implications of reducing each of the costs? For example, if the company reduces direct materials costs, it may have to do so by purchasing lower quality materials. This may affect sales in the long run.
(b) Based on your analysis in (a), what do you think is the best way to obtain the $70,000 in cost savings requested? Be specific. Are there any costs that cannot or should not be reduced? Why?
In order to better serve their rural patients, Drs. Greg and Don Kaye (brothers) began giving safety seminars. Especially popular were their “emergency preparedness” talks given to farmers. Many people asked whether the “kit” of materials the doctors recommended for common farm emergencies was commercially available.
After checking with several suppliers, the doctors realized that no other company offered the supplies they recommended in their seminars, packaged in the way they described. Their wives, Jo and Jan, agreed to make a test package by ordering supplies from various medical supply companies and assembling them into a “kit” that could be sold at the seminars. When these kits proved a runaway success, the sisters in law decided to market them. At the advice of their accountant, they organized this venture as a separate company, called First Aid Products (FAP), with Jo Kaye as CEO and Jan Kaye as Secretary Treasurer.
FAP soon started receiving requests for the kits from all over the country, as word spread about their availability. Even without advertising, FAP was able to sell its full inventory every month. However, the company was becoming financially strained. Jo and Jan had about $100,000 in savings, and they invested about half that amount initially. They believed that this venture would allow them to make money. However, at the present time, only about $30,000 of the cash remains, and the company is constantly short of cash.
Jo has come to you for advice. She does not understand why the company is having cash flow problems. She and Jan have not even been withdrawing salaries. However, they have rented a local building and have hired two more full time workers to help them cope with the increasing demand. They do not think they could handle the demand without this additional help.
Jo is also worried that the cash problems mean that the company may not be able to support itself. She has prepared the cash budget shown below. All seminar customers pay for their products in full at the time of purchase. In addition, several large companies have ordered the kits for use by employees who work in remote sites. They have requested credit terms and have been allowed to pay in the month following the sale. These large purchasers amount to about 25% of the sales at the present time. FAP purchases the materials for the kits about 2 months ahead of time. Jo and Jan are considering slowing the growth of the company by simply purchasing less materials, which will mean selling fewer kits.
The workers are paid in cash weekly. Jo and Jan need about $15,000 cash on hand at the beginning of the month to pay for purchases of raw materials. Right now they have been using cash from their savings, but as noted, only $30,000 is left.
Instructions
Write a response to Jo Kaye. Explain why FAP is short of cash. Will this company be able to support itself? Explain your answer. Make any recommendations you deem appropriate.
You are an accountant in the budgetary, projections, and special projects department of Tech Components, Inc., a large manufacturing company. The president, Sam White, asks you on very short notice to prepare some sales and income projections covering the next 2 years of the company’s much heralded new product lines. He wants these projections for a series of speeches he is making while on a 2 week trip to eight East Coast brokerage firms. The president hopes to bolster Tech’s stock sales and price.
You work 23 hours in 2 days to compile the projections, hand deliver them to the president, and are swiftly but graciously thanked as he departs. A week later, you find time to go over some of your computations and discover a miscalculation that makes the projections grossly overstated. You quickly inquire about the president’s itinerary and learn that he has made half of his speeches and has half yet to make. You are in a quandary as to what to do.
Instructions
(a) What are the consequences of telling the president of your gross miscalculations?
(b) What are the consequences of not telling the president of your gross miscalculations?
(c) What are the ethical considerations to you and the president in this situation?
The All About You feature (available on the book’s companion website) emphasizes that in order to get your personal finances under control, you need to prepare a personal budget. Assume that you have compiled the following information regarding your expected cash flows for a typical month.
Rent payment
$ 400
Miscellaneous costs
$110
Interest income
50
Savings
50
Income tax withheld
300
Eating out
150
Electricity bill
22
Telephone and Internet costs
90
Groceries
80
Student loan payments
275
Wages earned
2,000
Entertainment costs
250
Insurance
100
Transportation costs
150
Instructions
Using the information above, prepare a personal budget. In preparing this budget, use the format found. Just skip any unused line items.
Jeff Lynne (see E11 1) has studied the information you gave him in that exercise and has come to you with more statements about corporation.
1. Corporation management is both an advantage and a disadvantage of a corporation compared to a proprietorship or a partnership.
2. Limited liability of stockholders, government regulations, and additional taxes are the major disadvantages of a corporation.
3. When a corporation is formed, organization costs are recorded as an asset.
4. Each share of common stock gives the stockholder the ownership rights to vote at stockholder meetings, share in corporate earnings, keep the same percentage ownership when new shares of stock are issued, and share in assets upon liquidation.
5. The number of issued shares is always greater than or equal to the number of authorized shares.
6. A journal entry is required for the authorization of capital stock.
7. Publicly held corporations usually issue stock directly to investors.
8. The trading of capital stock on a securities exchange involves the transfer of already issued shares from an existing stockholder to another investor.
9. The market value of common stock is usually the same as its par value.
10. Retained earnings is the total amount of cash and other assets paid in to the corporation by stockholders in exchange for capital stock.
Instructions
Identify each statement as true or false. If false, indicate how to correct the statement.
Common stock, no par, 750,000 shares authorized, 600,000 shares issued
1,200,000
Total paid in capital
1,800,000
Retained earnings
1,858,000
Total paid in capital and retained earnings
3,658,000
Less:Treasury stock (12,000 common shares)
64,000
Total stockholders’ equity
$3,594,000
Instructions
From a review of the stockholders’ equity section, as chief accountant, write a memo to the president of the company answering the following questions.
(a) How many shares of common stock are outstanding?
(b) Assuming there is a stated value, what is the stated value of the common stock?
(c) What is the par value of the preferred stock?
(d) If the annual dividend on preferred stock is $30,000, what is the dividend rate on preferred stock?
(e) If dividends of $60,000 were in arrears on preferred stock, what would be the balance in Retained Earnings?
Flores Corporation recently hired a new accountant with extensive experience in accounting for partnerships. Because of the pressure of the new job, the accountant was unable to review his textbooks on the topic of corporation accounting. During the first month, the accountant made the following entries for the corporation’s capital stock.
May 2
Cash
Capital Stock
(Issued 10,000 shares of $10 par value common stock at $12 per share)
120,000
120,000
10
Cash
Capital Stock
(Issued 10,000 shares of $50 par value preferred stock at $60 per share)
600,000
600,000
15
Capital Stock
Cash
(Purchased 1,000 shares of common stock for the treasury at $14 per share)
14,000
14,000
31
Cash
Capital Stock
Gain on Sale of Stock
(Sold 500 shares of treasury stock at $16 per share)
8,000
5,000
3,000
Instructions
On the basis of the explanation for each entry, prepare the entry that should have been made for the capital stock transactions.
On January 1, Armada Corporation had 95,000 shares of no par common stock issued and outstanding. The stock has a stated value of $5 per share. During the year, the following occurred.
Apr. 1 Issued 15,000 additional shares of common stock for $17 per share.
June 15 Declared a cash dividend of $1 per share to stockholders of record on June 30.
July 10 Paid the $1 cash dividend.
Dec. 1 Issued 2,000 additional shares of common stock for $19 per share.
Dec. 15 Declared a cash dividend on outstanding shares of $1.20 per share to stockholders of record on December 31.
Instructions
(a) Prepare the entries, if any, on each of the three dividend dates.
(b) How are dividends and dividends payable reported in the financial statements prepared at December 31?
The ledger of O’Dell Corporation contains the following accounts: Common Stock, Preferred Stock, Treasury Stock—Common, Paid in Capital in Excess of Par Value—Preferred Stock, Paid in Capital in Excess of Stated Value—Common Stock, Paid in Capital from Treasury Stock, and Retained Earnings.
Instructions
Classify each account using the following table headings.
In a recent year, the stockholders’ equity section of Aluminum Company of America (Alcoa) showed the following (in alphabetical order): additional paid in capital $6,101, common stock $925, preferred stock $56, retained earnings $7,428, and treasury stock $2,828. All dollar data are in millions. The preferred stock has 557,740 shares authorized, with a par value of $100 and an annual $3.75 per share cumulative dividend preference. At December 31, 557,649 shares of preferred are issued and 546,024 shares are outstanding. There are 1.8 billion shares of $1 par value common stock authorized, of which 924.6 million are issued and 844.8 million are outstanding at December 31.
Instructions
(a) Prepare the stockholders’ equity section, including disclosure of all relevant data.
(b) Compute the book value per share of common stock, assuming there are no preferred dividends in arrears. (Round to two decimals.)
Perkins Corporation has collected the following information after its first year of sales. Net sales were $2,000,000 on 100,000 units; selling expenses $400,000 (30% variable and 70% fixed); direct materials $600,000; direct labor $340,000; administrative expenses $500,000 (30% variable and 70% fixed); manufacturing overhead $480,000 (20% variable and 80% fixed). Top management has asked you to do a CVP analysis so that it can make plans for the coming year. It has projected that unit sales will increase by 20% next year.
Instructions
(a) Compute (1) the contribution margin for the current year and the projected year, and (2) the fixed costs for the current year. (Assume that fixed costs will remain the same in the projected year.)
(b) Compute the break even point in units and sales dollars.
(c) The company has a target net income of $374,000. What is the required sales in dollars for the company to meet its target?
(d) If the company meets its target net income number, by what percentage could its sales fall before it is operating at a loss? That is, what is its margin of safety ratio?
(e) The company is considering a purchase of equipment that would reduce its direct labor costs by $140,000 and would change its manufacturing overhead costs to 10% variable and 90% fixed (assume total manufacturing overhead cost is $480,000, as above). It is also considering switching to a pure commission basis for its sales staff. This would change selling expenses to 80% variable and 20% fixed (assume total selling expense is $400,000, as above). Compute (1) the contribution margin and (2) the contribution margin ratio, and recompute (3) the break even point in sales dollars. Comment on the effect each of management’s proposed changes has on the break even point.
Azul Metal Company produces the steel wire that goes into the production of paper clips. In 2012, the first year of operations, Azul produced 50,000 miles of wire and sold 45,000 miles. In 2013, the production and sales results were exactly reversed. In each year, selling price per mile was $60, variable manufacturing costs were 20% of the sales price, variable selling expenses were $8.00 per mile sold, fixed manufacturing costs were $1,200,000, and fixed administrative expenses were $230,000.
Instructions
(a) Prepare comparative income statements for each year using variable costing.
(b) Prepare comparative income statements for each year using absorption costing.
(c) Reconcile the differences each year in income from operations under the two costing approaches.
(d) Comment on the effects of production and sales on net income under the two costing approaches.
Zumello Company has decided to introduce a new product. The new product can be manufactured by either a capital intensive method or a labor intensive method. The manufacturing method will not affect the quality of the product. The estimated manufacturing costs by the two methods are as follows.
Capital
Labor
Intensive
Intensive
Direct materials
$5 per unit
$5.50 per unit
Direct labor
$6 per unit
$8.00 per unit
Variable overhead
$3 per unit
$4.50 per unit
Fixed manufacturing costs
$2,508,000
$1,538,000
Zumello’s market research department has recommended an introductory unit sales price of $30. The incremental selling expenses are estimated to be $502,000 annually plus $2 for each unit sold, regardless of manufacturing method.
Instructions
With the class divided into groups, answer the following.
(a) Calculate the estimated break even point in annual unit sales of the new product if Zumello Company uses the:
(1) Capital intensive manufacturing method.
(2) Labor intensive manufacturing method.
(b) Determine the annual unit sales volume at which Zumello Company would be indifferent between the two manufacturing methods.
(c) Explain the circumstance under which Zumello should employ each of the two manufacturing methods.
The condensed income statement for the Penn and Stiller partnership for 2012 is as follows.
PENN AND STILLER COMPANY
Income Statement
For the Year Ended December 31, 2012
Sales (200,000 units)
$1,200,000
Cost of goods sold
800,000
Gross profit
400,000
Operating expenses
Selling
$280,000
Administrative
160,000
440,000
Net loss
($40,000)
A cost behavior analysis indicates that 75% of the cost of goods sold are variable, 50% of the selling expenses are variable, and 25% of the administrative expenses are variable.
Instructions
(a) Compute the break even point in total sales dollars and in units for 2012.
(b) Penn has proposed a plan to get the partnership “out of the red” and improve its profitability. She feels that the quality of the product could be substantially improved by spending $0.25 more per unit on better raw materials. The selling price per unit could be increased to only $6.25 because of competitive pressures. Penn estimates that sales volume will increase by 30%. What effect would Penn’s plan have on the profits and the break even point in dollars of the partnership? (Round the contribution margin ratio to two decimal places.)
(c) Stiller was a marketing major in college. She believes that sales volume can be increased only by intensive advertising and promotional campaigns. She therefore proposed the following plan as an alternative to Penn’s. (1) Increase variable selling expenses to $0.79 per unit, (2) lower the selling price per unit by $0.30, and (3) increase fixed selling expenses by $35,000. Stiller quoted an old marketing research report that said that sales volume would increase by 60% if these changes were made. What effect would Stiller’s plan have on the profits and the break even point in dollars of the partnership?
(d) Which plan should be accepted? Explain your answer.
Asheville Company is preparing its master budget for 2012. Relevant data pertaining to its sales and production budgets are as follows:
Sales: Sales for the year are expected to total 1,200,000 units. Quarterly sales, as a percentage of total sales, are 20%, 25%, 30%, and 25%, respectively. The sales price is expected to be $50 per unit for the first three quarters and $55 per unit beginning in the fourth quarter. Sales in the first quarter of 2013 are expected to be 10% higher than the budgeted sales volume for the first quarter of 2012.
Production: Management desires to maintain ending finished goods inventories at 25% of the next quarter’s budgeted sales volume.
Instructions
Prepare the sales budget and production budget by quarters for 2012.
Green River Company is preparing its master budget for 2012. Relevant data pertaining to its sales, production, and direct materials budgets are as follows.
Sales: Sales for the year are expected to total 1,000,000 units. Quarterly sales are 20%, 25%, 25%, and 30%, respectively. The sales price is expected to be $40 per unit for the first three quarters and $45 per unit beginning in the fourth quarter. Sales in the first quarter of 2013 are expected to be 10% higher than the budgeted sales for the first quarter of 2012.
Production: Management desires to maintain the ending finished goods inventories at 20% of the next quarter’s budgeted sales volume.
Direct materials: Each unit requires 2 pounds of raw materials at a cost of $10 per pound. Management desires to maintain raw materials inventories at 10% of the next quarter’s production requirements. Assume the production requirements for first quarter of 2013 are 500,000 pounds.
Prepare the sales, production, and direct materials budgets by quarters for 2012.
Ernst and Anderson, CPAs, are preparing their service revenue (sales) budget for the coming year (2012). The practice is divided into three departments: auditing, tax, and consulting. Billable hours for each department, by quarter, are provided below.
Department
Quarter 1
Quarter 2
Quarter 3
Quarter 4
Auditing
2,200
1,600
2,000
2,400
Tax
3,000
2,400
2,000
2,500
Consulting
1,500
1,500
1,500
1,500
Average hourly billing rates are: auditing $80, tax $90, and consulting $100.
Instructions
Prepare the service revenue (sales) budget for 2012 by listing the departments and showing for each quarter and the year in total, billable hours, billable rate, and total revenue.
Paulina Company produces and sells automobile batteries, the heavy duty HD 240. The 2012 sales budget is as follows.
Quarter
HD 240
1
5,000
2
7,000
3
8,000
4
10,000
The January 1, 2012, inventory of HD 240 is 2,500 units. Management desires an ending inventory each quarter equal to 50% of the next quarter’s sales. Sales in the first quarter of 2013 are expected to be 30% higher than sales in the same quarter in 2012.
Instructions
Prepare quarterly production budgets for each quarter and in total for 2012.
Ming Company expects to have a cash balance of $46,000 on January 1, 2012. Relevant monthly budget data for the first 2 months of 2012 are as follows.
Collections from customers: January $85,000, February $150,000.
Payments for direct materials: January $50,000, February $70,000.
Direct labor: January $30,000, February $45,000. Wages are paid in the month they are incurred.
Manufacturing overhead: January $21,000, February $25,000. These costs include depreciation of $1,000 per month. All other overhead costs are paid as incurred.
Selling and administrative expenses: January $15,000, February $20,000. These costs are exclusive of depreciation. They are paid as incurred.
Sales of marketable securities in January are expected to realize $10,000 in cash. Ming Company has a line of credit at a local bank that enables it to borrow up to $25,000. The company wants to maintain a minimum monthly cash balance of $20,000.
AIM Company’s budgeted sales and direct materials purchases are as follows.
Budgeted Sales
Budgeted D.M. Purchases
January
$200,000
$30,000
February
220,000
35,000
March
270,000
41,000
AIM’s sales are 40% cash and 60% credit. Credit sales are collected 10% in the month of sale,50% in the month following sale, and 36% in the second month following sale; 4% are uncollectible. AIM’s purchases are 50% cash and 50% on account. Purchases on account are paid 40% in the month of purchase, and 60% in the month following purchase.
Instructions
(a) Prepare a schedule of expected collections from customers for March.
(b) Prepare a schedule of expected payments for direct materials for March.
Home Exteriors Inc. is preparing its budget for the first quarter of 2012. The next step in the budgeting process is to prepare a cash receipts schedule and a cash payments schedule. To that end, the following information has been collected.
Clients usually pay 60% of their fee in the month that service is provided, 30% the month after, and 10% the second month after receiving service.
Actual service revenue for 2011 and expected service revenues for 2012 are: November 2011, $90,000; December 2011, $80,000; January 2012, $100,000; February 2012, $120,000; March 2012, $130,000.
Purchases of landscaping supplies (direct materials) are paid 40% in the month of purchase and 60% the following month. Actual purchases for 2011 and expected purchases for 2012 are: December 2011, $14,000; January 2012, $12,000; February 2012, $15,000; March 2012, $18,000.
Instructions
(a) Prepare the following schedules for each month in the first quarter of 2012 and for the quarter in total:
(1) Expected collections from clients.
(2) Expected payments for landscaping supplies.
(b) Determine the following balances at March 31, 2012:
Medina Dental Clinic is a medium sized dental service specializing in family dental care. The clinic is currently preparing the master budget for the first 2 quarters of 2012. All that remains in this process is the cash budget. The following information has been collected from other portions of the master budget and elsewhere.
Beginning cash balance
$ 30,000
Required minimum cash balance
25,000
Payment of income taxes (2nd quarter)
4,000
Professional salaries:
1st quarter
140,000
2nd quarter
140,000
Interest from investments (2nd quarter)
5,000
Overhead costs:
1st quarter
75,000
2nd quarter
100,000
Selling and administrative costs, including
$3,000 depreciation:
1st quarter
50,000
2nd quarter
70,000
Purchase of equipment (2nd quarter)
50,000
Sale of equipment (1st quarter)
15,000
Collections from clients:
1st quarter
230,000
2nd quarter
380,000
Interest payments (2nd quarter)
300
Instructions
Prepare a cash budget for each of the first two quarters of 2012.
Greene Farm Supply Company manufactures and sells a pesticide called Snare. The following data are available for preparing budgets for Snare for the first 2 quarters of 2013.
1. Sales: Quarter 1, 28,000 bags; quarter 2, 42,000 bags. Selling price is $60 per bag.
2. Direct materials: Each bag of Snare requires 4 pounds of Gumm at a cost of $4 per pound and 6 pounds of Tarr at $1.50 per pound.
3. Desired inventory levels:
Type of Inventory
January 1
April 1
July 1
Snare (bags)
8,000
12,000
18,000
Gumm (pounds)
9,000
10,000
13,000
Tarr (pounds)
14,000
20,000
25,000
4. Direct labor: Direct labor time is 15 minutes per bag at an hourly rate of $14 per hour.
5. Selling and administrative expenses are expected to be 15% of sales plus $175,000 per quarter.
6. Income taxes are expected to be 30% of income from operations.
Your assistant has prepared two budgets: (1) The manufacturing overhead budget shows expected costs to be 150% of direct labor cost. (2) The direct materials budget for Tarr shows the cost of Tarr purchases to be $297,000 in quarter 1 and $421,500 in quarter 2.
Instructions
Prepare the budgeted income statement for the first 6 months and all required supporting budgets by quarters. (Note: Use variable and fixed in the selling and administrative expense budget.) Do not prepare the manufacturing overhead budget or the direct materials budget for Tarr.
Singh Company prepares monthly cash budgets. Relevant data from operating budgets for 2013 are:
January
February
Sales
$350,000
$400,000
Direct materials purchases
110,000
130,000
Direct labor
90,000
100,000
Manufacturing overhead
70,000
75,000
Selling and administrative expenses
79,000
86,000
All sales are on account. Collections are expected to be 50% in the month of sale, 30% in the first month following the sale, and 20% in the second month following the sale. Sixty percent (60%) of direct materials purchases are paid in cash in the month of purchase, and the balance due is paid in the month following the purchase. All other items above are paid in the month incurred except for selling and administrative expenses that include $1,000 of depreciation per month.
Other data:
1. Credit sales: November 2012, $260,000; December 2012, $320,000.
2. Purchases of direct materials: December 2012, $100,000.
3. Other receipts: January—Collection of December 31, 2012, notes receivable $15,000; February—Proceeds from sale of securities $6,000.
4. Other disbursements: February—Withdrawal of $5,000 cash for personal use of owner, Dwight Yocum.
The company’s cash balance on January 1, 2013, is expected to be $60,000. The company wantsto maintain a minimum cash balance of $50,000.
Instructions
(a) Prepare schedules for (1) expected collections from customers and (2) expected payments for direct materials purchases.
(b) Prepare a cash budget for January and February in columnar form.
The All Cuts Barber Shop employs four barbers. One barber, who also serves as the manager, is paid a salary of $3,900 per month. The other barbers are paid $1,900 per month. In addition, each barber is paid a commission of $2 per haircut. Other monthly costs are: store rent $700 plus 60 cents per haircut, depreciation on equipment $500, barber supplies 40 cents per haircut, utilities $300, and advertising $100. The price of a haircut is $10.
Instructions
(a) Determine the variable cost per haircut and the total monthly fixed costs.
(b) Compute the break even point in units and dollars.
(c) Prepare a CVP graph, assuming a maximum of 1,800 haircuts in a month. Use increments of 300 haircuts on the horizontal axis and $3,000 increments on the vertical axis.
(d) Determine the net income, assuming 1,700 haircuts are given in a month.
Mobley Company bottles and distributes No FIZZ, a fruit drink. The beverage is sold for 50 cents per 16 ounce bottle to retailers, who charge customers 70 cents per bottle. For the year 2012, management estimates the following revenues and costs.
Net sales
$2,000,000
Selling expenses—variable
$ 80,000
Direct materials
360,000
Selling expenses—fixed
150,000
Direct labor
450,000
Administrative expenses—
Manufacturing overhead—
variable
40,000
variable
270,000
Administrative expenses—
Manufacturing overhead—
fixed
40,000
fixed
280,000
Instructions
(a) Prepare a CVP income statement for 2012 based on management’s estimates.
(b) Compute the break even point in (1) units and (2) dollars.
(c) Compute the contribution margin ratio and the margin of safety ratio.
(d) Determine the sales dollars required to earn net income of $390,000.
Werner Manufacturing had a bad year in 2012. For the first time in its history, it operated at a loss. The company’s income statement showed the following results from selling 60,000 units of product: Net sales $1,500,000; total costs and expenses $1,890,000; and net loss $390,000. Costs and expenses consisted of the amounts shown below.
Total
Variable
Fixed
Cost of goods sold
$1,350,000
$ 930,000
$420,000
Selling expenses
420,000
65,000
355,000
Administrative expenses
120,000
55,000
65,000
$1,890,000
$1,050,000
$840,000
Management is considering the following independent alternatives for 2013.
1. Increase unit selling price 40% with no change in costs, expenses, and sales volume.
2. Change the compensation of salespersons from fixed annual salaries totaling $200,000 to total salaries of $30,000 plus a 4% commission on net sales.
3. Purchase new high tech factory machinery that will change the proportion between variable and fixed cost of goods sold to 50:50.
Instructions
(a) Compute the break even point in dollars for 2012.
(b) Compute the break even point in dollars under each of the alternative courses of action. Which course of action do you recommend?
Kay Jo is the advertising manager for Costless Shoe Store. She is currently working on a major promotional campaign. Her ideas include the installation of a new lighting system and increased display space that will add $24,000 in fixed costs to the $210,000 currently spent. In addition, Kay is proposing that a 62/3% price decrease (from $30 to $28) will produce an increase in sales volume from 16,000 to 20,000 units. Variable costs will remain at $15 per pair of shoes. Management is impressed with Kay’s ideas but concerned about the effects that these changes will have on the break even point and the margin of safety.
Instructions
(a) Compute the current break even point in units, and compare it to the break even point in units if Kay’s ideas are used.
(b) Compute the margin of safety ratio for current operations and after Kay’s changes are introduced.
(c) Prepare a CVP income statement for current operations and after Kay’s changes are introduced. Would you make the changes suggested?
Electric utilities often have above average dividend yields. A distinctive characteristic of many utility companies is that they pay a high percentage of earnings as dividends, while periodically issuing new equity to invest in the many projects necessitated by the capital intensive nature of their business. This practice of financing dividends with new equity appears unwise because new equity is expensive. Researchers17 examining a set of U.S. based electric utilities, however, have demonstrated that there may be a good reason for paying dividends and then issuing equity: the mitigation of the agency problems between managers and shareholders and between utility regulators and utility shareholders.
Because electric utilities are typically monopolies in the sense that they are usually the only providers of electricity in a given area, they are regulated so they are not able to set electricity rates at monopolistically high levels. The regulators are expected to set rates such that the company’s operating expenses are met and investors are provided with a fair return. The regulators, however, are usually elected, or are political appointees, and view ratepayers as potential voters. Thus, utility shareholders, in addition to facing potential manager–shareholder agency issues because managers have incentives to consume perquisites or to over invest, also face a regulator–shareholder conflict, in which regulators set rates low to attract the votes of individuals being served by the utility.
In the utility industry, therefore, dividends and the subsequent equity issue are used as mechanisms to monitor managers and regulators. The company pays high dividends and then goes to the capital markets to issue new equity. If the market does not think that shareholders are getting a fair return because regulators are setting rates too low, or because managers are consuming too many perks, the price at which new equity can be sold will fall until the shareholder expectations for returns are met. As a result, the company may not be able to raise sufficient funds to expand its plant to meet increasing electricity demand—the electric utility industry is very capital intensive—and, in the extreme, the lights may go out. Faced with this possibility, and potentially angry voters, regulators have incentives to set rates at a fair level. Thus, the equity market serves to monitor and arbitrate conflicts between shareholders and both managers and regulators.
On 8 May 2009, Toyota Motor Company, the world’s largest automobile manufacturer, announced that it was going to cut its dividend for the first time. Toyota, which pays dividends twice a year, said the dividend would be reduced to ¥35 a share from the ¥75 paid a year earlier. The 2008 total dividend was ¥140 a share. The dividend cut ends a 600 percent cumulative increase in the dividend over 10 years. Faced with plunging global demand for cars (Toyota’s vehicle sales were forecasted to fall 14 percent) and ongoing turmoil in the auto industry, Toyota was expecting a loss as high as ¥550 billion (operating loss of ¥850 billion) for fiscal year ending March 2010, compared with the analyst forecast loss of ¥284 billion for the same period. The company already had a loss of ¥437 billion in fiscal year 2009 (the operating loss was ¥461 billion). Toyota is focused on aggressively cutting costs—it plans to cut production related costs by ¥340 billion and fixed costs by ¥460 billion—and has said that the lower dividend is because of the difficulty of sustaining the dividend at its previous level. Board member bonuses have been eliminated and manager summer bonuses were reduced by 60 percent. Capital spending will be cut by 36 percent to ¥830 billion, and R&D spending will be cut by 9.3 percent to ¥820 billion.
The company announced plans to raise capital via a bond issue of as much as ¥700 billion. Standard & Poor’s cut Toyota’s bond rating from AA+ to AA. Another problem facing Toyota and other Japanese automakers is the strong yen, which has gained 13 percent against the U.S. dollar in the preceding quarter. Toyota said that a one yen gain against the dollar trims profits by about ¥30 billion and that a similar gain against the euro trims profits by ¥4 billion.
Discuss Toyota’s decision to cut its dividend in light of the factors affecting dividend policy covered in this section.
Cal Maine Foods, Inc. (NASDAQ: CALM) is the leading egg producer in the United States. Cal Maine’s earnings tend to be highly volatile. Demand for eggs is seasonal, typically being higher in winter than in summer. On the supply side, costs are driven, to a great extent, by corn prices that are subject to business cycle influences and are thus very volatile. In consideration of earnings volatility, Cal Maine might have difficulty sustaining a steadily rising dividend level. Probably in view of such considerations, Cal Maine changed its dividend policy from a stable dividend policy to a constant dividend payout ratio policy (denoted a “variable dividend policy” by management) in its fiscal year 2008. The following is the explanation by the company:
“We have paid cash dividends on our Common Stock since 1998. The annual dividend rate of $0.05 per share of Common Stock, or $0.0125 per quarter, was paid in each of the fiscal quarters shown in the table above, through the second quarter of fiscal 2008. We have also paid cash dividends on our Class A Common Stock at a rate equal to 95 percent of the annual rate on our Common Stock.
Effective 30 November 2007, the Company’s Board of Directors approved the adoption of a variable dividend policy to replace the Company’s fixed dividend policy. Commencing with the third quarter of fiscal 2008 Cal Maine began to pay a dividend to shareholders of its Common Stock and Class A Common Stock on a quarterly basis for each quarter for which the Company reports net income computed in accordance with generally accepted accounting principles in an amount equal to one third (1/3) of such quarterly income. The amount of the dividend payable on each share of Class A Common Stock is in an amount equal to 95 percent of the amount paid on each share of Common Stock. Dividends are paid to shareholders of record as of the sixtieth day following the last day of such quarter, and are payable on the fifteenth day following the record date. Following a quarter for which the Company does not report net income, the Company shall not pay a dividend for a subsequent profitable quarter until the Company is profitable on a cumulative basis computed from the date of the last quarter for which a dividend was paid.
Management and Board of Directors of Cal Maine believe the variable dividend policy will more accurately reflect the results of our operations while recognizing and allowing for the cyclicality of the egg industry.”
Earnings per Share (EPS) and Dividends per Share (DPS) for Cal Maine Foods (Fiscal Years End 31 or 30 May)
Fiscal Period
EPS ($)
DPS ($)
2009:Q4
0.43
0.1438
2009:Q3
1.30
0.4322
2009:Q2
1.15
0.3817
2009:Q1
0.47
0.1570
2008:Q4
1.54
0.5138
2008:Q3
2.41
0.8038
2008:Q2
1.70
0.0125
2008:Q1
0.76
0.0125
1. From the table above, identify the fiscal quarter when Cal Maine first applied a constant dividend payout ratio policy.
2. Demonstrate that the dividend for 2009:Q4 reflects the stated current dividend policy.
1. Suppose a company has €900 million in planned capital spending (representing positive NPV projects). The company’s target capital structure is 60 percent debt and 40 percent equity. Given that the company follows a residual dividend policy, the company’s indicated dividend with earnings of €500 million is closest to:
A. €140 million.
B. €360 million.
C. €500 million.
2. Suppose a company has paid semiannual dividends of €3 a share over the prior two years and €2.75 for four years prior. During that six year period, earnings and capital expenditure needs have shown considerable interim variability and dividend payout ratios have ranged from 55 to 86 percent, with an average of 65 percent. In the current six month period, suppose that 8 million shares are issued and outstanding and that earnings are anticipated to be €28 million. The company has €5 million in planned capital spending for the six month period (representing positive NPV projects). The company’s long term target capital structure is 50 percent debt and 50 percent equity. Based on the facts given, the most likely dividend per share for the current six month period is:
A. €2.28.
B. €3.00.
C. €3.19.
Given the following data, calculate the dividend payout and coverage ratios:
Harley Davidson, Inc. (NYSE symbol HOG), produces and sells luxury motorcycles in the United States and Europe. The company has paid dividends since 1993.
Years Ending 31 December (US$ millions)
2006
2007
2008
Net income (earnings)
$1,043
$934
$655
Cash flow from operations
762
798
(685)
FCInv (capital expenditures)
220
242
332
Net borrowing
493
352
1,845
Dividends paid
213
261
302
Stock repurchases
936
1,132
249
Yahoo! Finance website, 24 July 2009.
1. Using the above information, calculate the following for 2006, 2007, and 2008:
A. Dividend/earnings payout ratio
B. Earnings/dividend coverage ratio
C. Free cash flow to equity (FCFE)
D. FCFE/[dividend+stock repurchase] coverage ratio
2. Discuss the trend in earnings/dividend coverage as compared with the trend in FCFE/[dividend+stock repurchase] coverage.
3. Comment on the sustainability of HOG’s dividend and stocks repurchase policy after 2008.
Scottsville Instruments, Inc., (SCII) is a U.S. based company emerging as a leader in providing medical testing equipment to the pharmaceutical and biotechnology industries. SCII’s primary markets are growing and the company is spending $100 million a year on research and development to enhance its competitive position. SCII is highly profitable and has substantial positive free cash flow after funding positive NPV projects. During the past three years, SCII has made significant share repurchases. Subsequent to the reduction in the tax rate on cash dividends to 15 percent in the United States, the same tax rate as that on long term capital gains, SCII management is proposing the initiation of a cash dividend. The first dividend is proposed to be an annual dividend of $0.40 a share to be paid during the next fiscal year. Based on estimated earnings per share of $3.20, this dividend would represent a payout ratio (DPS/EPS) of 0.125 or 12.5 percent. The proposal that will be brought before the board of directors is the following:
Proposed: Scottsville Instruments, Inc., will institute a program of cash dividends. The first dividend will be an annual dividend of $0.40 a share, to be paid at a time to be determined during the next fiscal year. Thereafter, an annual dividend will be paid consistent with retaining funds sufficient to finance profitable capital projects.
The company’s board of directors will formally consider the dividend proposal at its next meeting in one month’s time. Although some directors favor the dividend initiation proposal, other directors, led by William Marshall, are skeptical of it. Marshall has stated:
“The initiation of a cash dividend will suggest to investors that SCII is no longer a growth company.”
As a counterproposal, Marshall has offered his support for the initiation of an annual 2 percent stock dividend. Elise Tashman, a director who is neutral to both the cash dividends and stock dividend ideas, has told Marshall the following:
“A 2 percent stock dividend will not affect the wealth of our shareholders.”
presents selected pro forma financials of SCII, if the directors approve the initiation of a cash dividend.
Scottsville Instruments, Inc., Pro Forma Financial Data Assuming Cash Dividend ($ millio
On 7 November 2007, Siemens AG, a world leader in electrical and electronic equipment, reported that in order to optimize its capital structure it would repurchase shares by fiscal year end 2010 to achieve a target ratio of net industrial debt to EBITDA in the range 0.8× 1.0×. Accordingly, Siemens said it could repurchase shares in the amount up to €10 billion in several tranches. Siemens’ repurchases in the first two tranches were as follows:
Janet Wu is treasurer of Wilson Paper Company, a manufacturer of paper products for the office and school markets. Wilson Paper is selling one of its divisions for $70 million cash. Wu is considering whether to recommend a special dividend of $70 million or a repurchase of 2 million shares of Wilson common stock in the open market. She is reviewing some possible effects of the buyback with the company’s financial analyst. Wilson has a long term record of gradually increasing earnings and dividends. Wilson’s board has also approved capital spending of $15 million to be entirely funded out of this year’s earnings.
Book value of equity
$750 million ($30 a share)
Shares outstanding
25 million
12 month trading range
$25–$35
Current share price
$35
After tax cost of borrowing
7%
Estimated full year earnings
$25 million
Last year’s dividends
$9 million
Target debt/equity (market value)
35/65
In investors’ minds, Wilson’s share buyback could be a signal that the company:
A. is decreasing its financial leverage.
B. views its shares as undervalued in the marketplace.
C. has more investment opportunities than it could fund internally.
Janet Wu is treasurer of Wilson Paper Company, a manufacturer of paper products for the office and school markets. Wilson Paper is selling one of its divisions for $70 million cash. Wu is considering whether to recommend a special dividend of $70 million or a repurchase of 2 million shares of Wilson common stock in the open market. She is reviewing some possible effects of the buyback with the company’s financial analyst. Wilson has a long term record of gradually increasing earnings and dividends. Wilson’s board has also approved capital spending of $15 million to be entirely funded out of this year’s earnings.
Book value of equity
$750 million ($30 a share)
Shares outstanding
25 million
12 month trading range
$25–$35
Current share price
$35
After tax cost of borrowing
7%
Estimated full year earnings
$25 million
Last year’s dividends
$9 million
Target debt/equity (market value)
35/65
Assume that Wilson Paper funds its capital spending out of its estimated full year earnings. If Wilson uses a residual dividend policy, determine Wilson’s implied dividend payout ratio:
Janet Wu is treasurer of Wilson Paper Company, a manufacturer of paper products for the office and school markets. Wilson Paper is selling one of its divisions for $70 million cash. Wu is considering whether to recommend a special dividend of $70 million or a repurchase of 2 million shares of Wilson common stock in the open market. She is reviewing some possible effects of the buyback with the company’s financial analyst. Wilson has a long term record of gradually increasing earnings and dividends. Wilson’s board has also approved capital spending of $15 million to be entirely funded out of this year’s earnings.
Book value of equity
$750 million ($30 a share)
Shares outstanding
25 million
12 month trading range
$25–$35
Current share price
$35
After tax cost of borrowing
7%
Estimated full year earnings
$25 million
Last year’s dividends
$9 million
Target debt/equity (market value)
35/65
The most likely tax environment in which Wilson Paper’s shareholders would prefer that Wilson repurchase its shares (share buybacks) instead of paying dividends is one in which:
A. the tax rate on capital gains and dividends is the same.
B. capital gains tax rates are higher than dividend income tax rates.
C. capital gains tax rates are lower than dividend income tax rates.
Pyle Company manufactures a single product. Annual production costs incurred in the manufacturing process are shown below for two levels of production.
Costs Incurred
Production in Units
5,000
10,000
Total
Cost/
Total
Cost/
Production Costs
Cost
Unit
Cost
Unit
Direct materials
$8,250
$1.65
$16,500
$1.65
Direct labor
9,500
1.90
19,000
1.90
Utilities
1,500
0.30
2,500
0.25
Rent
4,000
0.80
4,000
0.40
Maintenance
800
0.16
1,100
0.11
Supervisory salaries
1,000
0.20
1,000
0.10
Instructions
(a) Define the terms variable costs, fixed costs, and mixed costs.
(b) Classify each cost above as either variable, fixed, or mixed.
Airport Connection provides shuttle service between four hotels near a medical center and an international airport. Airport Connection uses two 10 passenger vans to offer 12 round trips per day. A recent month’s activity in the form of a cost volume profit income statement is shown below.
Fare revenues (1,440 fares)
$36,000
Variable costs
Fuel
$ 5,040
Tolls and parking
3,100
Maintenance
500
8,640
Contribution margin
27,360
Fixed costs
Salaries
13,000
Depreciation
1,300
Insurance
1,128
15,428
Net income
$11,932
Instructions
(a) Calculate the break even point in (1) dollars and (2) number of fares.
(b) Without calculations, determine the contribution margin at the break even point.
Titus Company manufactures and distributes industrial air compressors. The following costs are available for the year ended December 31, 2012. The company has no beginning inventory. In 2012, 1,500 units were produced, but only 1,300 units were sold. The unit selling price was $4,500. Costs and expenses were:
Variable costs per unit
$ 1,000
Direct materials
1,500
Direct labor
300
Variable manufacturing overhead
70
Variable selling and administrative expenses
Annual fixed costs and expenses
Manufacturing overhead
$1,400,000
Selling and administrative expenses
100,000
Instructions
(a) Compute the manufacturing cost of one unit of product using variable costing.
(b) Prepare a 2012 income statement for Titus Company using variable costing.
Stan Loy owns the Vista Barber Shop. He employs five barbers and pays each a base rate of $1,000 per month. One of the barbers serves as the manager and receives an extra $500 per month. In addition to the base rate, each barber also receives a commission of $5.50 per haircut.
Other costs are as follows.
Advertising
$200 per month
Rent
$900 per month
Barber supplies
$0.30 per haircut
Utilities
$175 per month plus $0.20 per haircut
Instructions
(a) Determine the variable cost per haircut and the total monthly fixed costs.
(b) Compute the break even point in units and dollars.
(c) Prepare a CVP graph, assuming a maximum of 1,800 haircuts in a month. Use increments of 300 haircuts on the horizontal axis and $3,000 on the vertical axis.
(d) Determine net income, assuming 1,900 haircuts are given in a month.
Magic Manufacturing’s sales slumped badly in 2012. For the first time in its history, itoperated at a loss. The company’s income statement showed the following results from selling 600,000 units of product: Net sales $2,400,000; total costs and expenses $2,540,000; and net loss $140,000. Costs and expenses consisted of the amounts shown below.
Total
Variable
Fixed
Cost of goods sold
$2,100,000
$1,440,000
$660,000
Selling expenses
240,000
72,000
168,000
Administrative expenses
200,000
48,000
152,000
$2,540,000
$1,560,000
$980,000
Management is considering the following independent alternatives for 2013.
1. Increase unit selling price 20% with no change in costs, expenses, and sales volume.
2. Change the compensation of salespersons from fixed annual salaries totaling $150,000 to total salaries of $60,000 plus a 3% commission on net sales.
3. Purchase new automated equipment that will change the proportion between variable and fixed cost of goods sold to 54% variable and 46% fixed.
Instructions
(a) Compute the break even point in dollars for 2012.
(b) Compute the break even point in dollars under each of the alternative courses of action. Which course of action do you recommend?
Lopez Corporation has collected the following information after its first year of sales.
Net sales were $1,600,000 on 100,000 units; selling expenses $240,000 (40% variable and 60% fixed); direct materials $511,000; direct labor $285,000; administrative expenses $280,000 (20% variable and 80% fixed); manufacturing overhead $360,000 (70% variable and 30% fixed). Top management has asked you to do a CVP analysis so that it can make plans for the coming year.
It has projected that unit sales will increase by 10% next year.
Instructions
(a) Compute (1) the contribution margin for the current year and the projected year, and (2) the fixed costs for the current year. (Assume that fixed costs will remain the same in the projected year.)
(b) Compute the break even point in units and sales dollars for the current year.
(c) The company has a target net income of $310,000. What is the required sales in dollars for the company to meet its target?
(d) If the company meets its target net income number, by what percentage could its sales fall before it is operating at a loss? That is, what is its margin of safety ratio?
(e) The company is considering a purchase of equipment that would reduce its direct labor costs by $104,000 and would change its manufacturing overhead costs to 30% variable and 70% fixed (assume total manufacturing overhead cost is $360,000, as above). It is also considering switching to a pure commission basis for its sales staff. This would change selling expenses to 90% variable and 10% fixed (assume total selling expense is $240,000, as above). Assuming that net sales remain at first year levels, compute (1) the contribution margin and (2) the contribution margin ratio, and re compute (3) the break even point in sales dollars. Comment on the effect each of management’s proposed changes has on the break even point.
BLT produces plastic that is used for injection molding applications such as gears for small motors. In 2012, the first year of operations, BLT produced 6,000 tons of plastic and sold 5,000 tons. In 2013, the production and sales results were exactly reversed. In each year, selling price per ton was $1,000, variable manufacturing costs were 15% of the sales price of units produced, variable selling expenses were 10% of the selling price of units sold, fixed manufacturing costs were $2,100,000, and fixed administrative expenses were $500,000.
Instructions
(a) Prepare comparative income statements for each year using variable costing.
(b) Prepare comparative income statements for each year using absorption costing.
(c) Reconcile the differences each year in income from operations under the two costing approaches.
(d) Comment on the effects of production and sales on net income under the two costing approaches.
Darby Electronics manufactures two large screen television models: the Royale which sells for $1,500, and a new model, the Majestic, which sells for $1,200.The production cost per unit for each model in 2010 was as follows.
Royale
Majestic
Direct materials
$ 700
$420
Direct labor ($20 per hour)
100
80
Manufacturing overhead ($40 per DLH)
200
160
Total per unit cost
$1,000
$660
In 2010, Darby manufactured 30,000 units of the Royale and 10,000 units of the Majestic. The overhead rate of $40 per direct labor hour was determined by dividing total expected manufacturing overhead of $7,600,000 by the total direct labor hours (190,000) for the two models. The gross profit on the model was: Royale $500 ($1,500 _ $1,000) and Majestic $540 ($1,200 _ $660). Because of this difference, management is considering phasing out the Royale model and increasing the production of the Majestic model. Before finalizing its decision, management asks the controller, Marie Stumfall, to prepare an analysis using activity based costing. Marie accumulates the following information about overhead for the year ended December 31, 2010.
Cost
Total
Driver
Overhead
Activity
Cost Driver
Cost
Volume
Rate
Purchase orders
Number of orders
$1,200,000
30,000
$40
Machine setups
Number of setups
900,000
15,000
60
Machining
Machine hours
4,800,000
160,000
30
Quality control
Number of inspections
700,000
35,000
20
The cost driver volume for each product was:
Cost Driver
Royale
Majestic
Total
Purchase orders
16,000
14,000
30,000
Machine setups
5,000
10,000
15,000
Machine hours
100,000
60,000
160,000
Inspections
10,000
25,000
35,000
Instructions
(a) Assign the total 2010 manufacturing overhead costs to the two products using activity based costing (ABC).
(b) What was the cost per unit and gross profit of each model using ABC costing?
(c) Are management’s future plans for the two models sound?
Walters Corporation manufactures water skis through two processes: Molding and Packaging. In the Molding Department fiberglass is heated and shaped into the form of a ski. In the Packaging Department, the skis are placed in cartons and sent to the finished goods warehouse. Materials are entered at the beginning of both processes. Labor and manufacturing overhead are incurred uniformly throughout each process. Production and cost data for the Molding Department for January 2010 are presented below.
Production Data
January
Beginning work in process units
–0–
Units started into production
42,500
Ending work in process units
2,500
Percent complete—ending inventory
40%
Cost Data
Materials
$510,000
Labor
96,000
Overhead
150,000
Total
$756,000
Instructions
(a) Compute the physical units of production.
(b) Determine the equivalent units of production for materials and conversion costs.
(c) Compute the unit costs of production.
(d) Determine the costs to be assigned to the units transferred out and in process.
(e) Prepare a production cost report for the Molding Department for the month of January.
Slocum Corporation manufactures in separate processes refrigerators and freezers for homes. In each process, materials are entered at the beginning and conversion costs are incurred uniformly. Production and cost data for the first process in making two products in two different manufacturing plants are as follows.
Stamping Department
Production Data—June
Plant A R12 Refrigerators
Plant B F24 Freezers
Work in process units, June 1
–0–
–0–
Units started into production
21,000
20,000
Work in process units, June 30
4,000
2,500
Work in process percent complete
75
60
Cost Data—June
Work in process, June 1
$ –0–
$ –0–
Materials
840,000
720,000
Labor
220,000
221,000
Overhead
420,000
292,000
Total
$1,480,000
$1,233,000
Instructions
(a) For each plant:
(1) Compute the physical units of production.
(2) Compute equivalent units of production for materials and for conversion costs.
(3) Determine the unit costs of production.
(4) Show the assignment of costs to units transferred out and in process.
(b) Prepare the production cost report for Plant A for June 2010.
Buehler Company manufactures a nutrient, Everlife, through two manufacturing processes: Blending and Packaging. All materials are entered at the beginning of each process. On August 1, 2010, inventories consisted of Raw Materials $5,000,Work in Process—Blending $0,Work in Process—Packaging $3,945, and Finished Goods $7,500.The beginning inventory for Packaging consisted of 500 units, two fifths complete as to conversion costs and fully complete as to materials. During August, 9,000 units were started into production in Blending, and the following transactions were completed.
1. Purchased $25,000 of raw materials on account.
2. Issued raw materials for production: Blending $18,930 and Packaging $9,140.
3. Incurred labor costs of $23,770.
4. Used factory labor: Blending $13,320 and Packaging $10,450.
5. Incurred $41,500 of manufacturing overhead on account.
6. Applied manufacturing overhead at the rate of $25 per machine hour. Machine hours were Blending 900 and Packaging 300.
7. Transferred 8,200 units from Blending to Packaging at a cost of $44,940.
8. Transferred 8,600 units from Packaging to Finished Goods at a cost of $67,490.
9. Sold goods costing $62,000 for $90,000 on account.
Marte Company manufactures bicycles and tricycles. For both products, materials are added at the beginning of the production process, and conversion costs are incurred uniformly. Production and cost data for the month of May are as follows.
Production Data—Bicycles
Units
Percent Complete
Work in process units, May 1
500
80%
Units started in production
1,500
Work in process units, May 31
800
25%
Cost Data—Bicycles
Work in process, May 1
Materials
$15,000
Conversion costs
18,000
$ 33,000
Direct materials
50,000
Direct labor
18,320
Manufacturing overhead
33,680
Instructions
(a) Calculate the following.
(1) The equivalent units of production for materials and conversion.
(2) The unit costs of production for materials and conversion costs.
(3) The assignment of costs to units transferred out and in process at the end of the accounting period.
(b) Prepare a production cost report for the month of May for the bicycles.
Sunshine Beach Company manufactures suntan lotion, called Surtan, in 11 ounce plastic bottles. Surtan is sold in a competitive market. As a result, management is very costconscious. Surtan is manufactured through two processes: mixing and filling. Materials are entered at the beginning of each process and labor and manufacturing overhead occur uniformly throughout each process. Unit costs are based on the cost per gallon of Surtan using the weighted average costing approach. On June 30, 2010, Jill Ritzman, the chief accountant for the past 20 years, opted to take early retirement. Her replacement, Sid Benili, had extensive accounting experience with motels in the area but only limited contact with manufacturing accounting. During July, Sid correctly accumulated the following production quantity and cost data for the Mixing Department. Production quantities: Work in process, July 1, 8,000 gallons 75% complete; started into production 91,000 gallons; work in process, July 31, 5,000 gallons 20% complete. Materials are added at the beginning of the process. Production costs: Beginning work in process $88,000, comprised of $21,000 of materials costs and $67,000 of conversion costs; incurred in July: materials $573,000, conversion costs $769,000.
Sid then prepared a production cost report on the basis of physical units started into production.
His report showed a production cost of $15.71 per gallon of Surtan. The management of Sunshine Beach was surprised at the high unit cost. The president comes to you, as Jill’s top assistant, to review Sid’s report and prepare a correct report if necessary.
Instructions
With the class divided into groups, answer the following questions.
(a) Show how Sid arrived at the unit cost of $15.71 per gallon of Surtan.
(b) What error(s) did Sid make in preparing his production cost report?
(c) Prepare a correct production cost report for July.
Carol Gorden was a good friend of yours in high school and is from your home town. While you chose to major in accounting when you both went away to college, she majored in marketing and management.You have recently been promoted to accounting manager for the Snack Foods Division of Koonce Enterprises, and your friend was promoted to regional sales manager for the same division of Koonce. Carol recently telephoned you. She explained that she was familiar with job cost sheets, which had been used by the Special Projects division where she had formerly worked. She was, however, very uncomfortable with the production cost reports prepared by your division. She faxed you a list of her particular questions:
1. Since Koonce occasionally prepares snack foods for special orders in the Snack Foods Division, why don’t we track costs of the orders separately?
2. What is an equivalent unit?
3. Why am I getting four production cost reports? Isn’t there one Work in Process account?
Instructions
Prepare a memo to Carol. Answer her questions, and include any additional information you think would be helpful. You may write informally, but do use proper grammar and punctuation.
R. B. Patrick Company manufactures a high tech component that passes through two production processing departments, Molding and Assembly. Department managers are partially compensated on the basis of units of products completed and transferred out relative to units of product put into production. This was intended as encouragement to be efficient and to minimize waste.
Sue Wooten is the department head in the Molding Department, and Fred Barando is her quality control inspector. During the month of June, Sue had three new employees who were not yet technically skilled. As a result, many of the units produced in June had minor molding defects. In order to maintain the department’s normal high rate of completion, Sue told Fred to pass through inspection and on to the Assembly Department all units that had defects nondetectable to the human eye. “Company and industry tolerances on this product are too high anyway,” says Sue. “Less than 2% of the units we produce are subjected in the market to the stress tolerance we’ve designed into them.The odds of those 2% being any of this month’s units are even less. Anyway, we’re saving the company money.”
Instructions
(a) Who are the potential stakeholders involved in this situation?
(b) What alternatives does Fred have in this situation? What might the company do to prevent this situation from occurring?
Many of you ultimately will work in service environments, such as medical facilities. Many service organizations have adopted activity based management systems, which incorporate activity based costing concepts throughout the organization. East Valley Hospital is a primary medical health care facility and trauma center that serves 11 small, rural Midwestern communities within a 40 mile radius. The hospital offers all the medical/ surgical services of a typical small hospital. It has a staff of 18 full time doctors and 20 part time visiting specialists. East Valley has a payroll of 150 employees, consisting of nurses, technicians, therapists, dieticians, managers, directors, administrators, secretaries, data processors, and janitors.
Instructions
(a) Using your existing knowledge (however limited, moderate, or in depth) of a hospital’s operations, identify as many activities as you can that would serve as the basis for implementing an activity based costing system.
(b) For each of the activities listed in (a), identify a cost driver that would serve as a valid measure of the resources consumed in the activity.
B.T. Hernandez Company, maker of high quality flashlights, has experienced steady growth over the last 6 years. However, increased competition has led Mr. Hernandez, the president, to believe that an aggressive campaign is needed next year to maintain the company’s present growth.The company’s accountant has presented Mr. Hernandez with the following data for the current year, 2010, for use in preparing next year’s advertising campaign.
Cost Schedules
Variable costs
Direct labor per flashlight
$ 8.00
Direct materials
4.00
Variable overhead
3.00
Variable cost per flashlight
$15.00
Fixed costs
Manufacturing
$ 25,000
Selling
40,000
Administrative
70,000
Total fixed costs
$135,000
Selling price per flashlight
$25.00
Expected sales, 2010 (20,000 flashlights)
$500,000
Mr. Hernandez has set the sales target for the year 2011 at a level of $550,000 (22,000 flashlights).
Instructions
(Ignore any income tax considerations.)
(a)What is the projected operating income for 2010?
(b)What is the contribution margin per unit for 2010?
(c) What is the break even point in units for 2010?
(d) Mr. Hernandez believes that to attain the sales target in the year 2011, the company must incur an additional selling expense of $10,000 for advertising in 2011, with all other costs remaining constant.What will be the break even point in dollar sales for 2011 if the company spends the additional $10,000?
(e) If the company spends the additional $10,000 for advertising in 2011, what is the sales level in dollars required to equal 2010 operating income?
In March 2009, Citigroup, a major U.S. based global bank, was in severe financial distress and required significant U.S. government investment. Citigroup announced it would seek shareholder approval for up to a 1 for 30 reverse split. At that time, the stock was perilously close to the $1 a share minimum price required for continued listing on the NYSE. In July 2009, the reverse split had not yet taken place, but the shares were trading at $2.90.
1. If the reverse split were to take place when the share price was $2.90 on the day before the ex dividend date, find the expected stock price after a 1 for 30 split, all other factors remaining unchanged.
2. Comment on the following statement: “Shareholder wealth is negatively affected by a reverse stock split.”
In mid 2009, Paul Desroches, a France based investor, is considering investment in the shares of Paris headquartered Total SA (Euronext Paris: FP), one of the world’s largest integrated oil companies and a major chemical manufacturer. Total pays a cash dividend twice a year, so the amount of the semiannual cash dividend is significant: almost a 3 percent cash dividend yield per six month period, or 6 percent annually, based on current share prices. Desroches reasons that Total’s high dividend yield is particularly attractive in the 2009 context of low yields on short term investment grade bonds. Desroches decides to buy Total shares on the last possible trading day he can to receive an announced dividend. He explains to a colleague, “It would be like buying a bond on the last day of a six month period without having to pay the seller accrued interest yet receiving the interest for the entire six months.”
On 15 May 2009, Total reported that shareholders had adopted the board of directors’ resolution to pay a dividend of €1.14 per share in May 2009. The relevant dates are
Ex date
Tuesday, 19 May
Payment date
Monday, 22 June
Using only the above information and ignoring taxes and any tax effects, address the following:
1. Assuming all of Desroches’s assumptions are correct, what is the last date he could buy the stock and still receive the dividend?
2. If Total closed at €38.39 a share on the last day Desroches was entitled to the dividend, what is the likely opening price on the next day assuming all other factors are unchanged?
Takemiya Industries, a Japanese company, has been accumulating cash in recent years with a plan of expanding in emerging Asian markets. The global recession has persuaded Takemiya’s management and directors that such expansion is no longer practical, and they are considering a share repurchase using surplus cash. Takemiya has 10 million shares outstanding and its net income is ¥100 million. Takemiya’s share price is ¥120. Cash not needed for operations totals ¥240 million and is invested in Japanese government short term securities that earn virtually zero interest. For a share repurchase program of the contemplated size, Takemiya’s investment bankers think the stock could be bought in the open market at a ¥20 premium to the current market price, or ¥140 a share. Calculate the impact on EPS if Takemiya uses the surplus cash to repurchase shares at ¥140 per share.
Jensen Farms, Inc., plans to borrow $12 million, which it will use to repurchase shares. The following information is given:
Share price at time of share repurchase=$60
Earnings after tax=$6.6 million
EPS before share repurchase=$3
Price/Earnings ratio (P/E)=$60/$3=20
Earnings yield (E/P)=$3/$60=5%
Shares outstanding=2.2 million
Planned share repurchase=200,000 shares
1. Calculate the EPS after the share repurchase, assuming the after tax cost of borrowing is the company’s customary after tax borrowing rate of 5 percent.
2. Calculate the EPS after the share repurchase, assuming the company’s borrowing rate increases to 6 percent because of the increased financial risk of borrowing the $12 million.
Waynesboro Chemical Industries, Inc. (WCII), has 10 million shares outstanding with a current market value of $20 per share. WCII’s board of directors is considering two ways of distributing WCII’s current $50 million free cash flow to equity. The first method involves paying an irregular or special cash dividend of $50 million/10 million=$5 per share. The second method involves repurchasing $50 million worth of shares. For simplicity, we make the assumptions that dividends are received when the shares go ex dividend and that any quantity of shares can be bought at the market price of $20 per share. We also assume that the taxation and information content of cash dividends and share repurchases, if any, do not differ. How would the wealth of a shareholder be affected by WCII’s choice of method in distributing the $50 million?
A. Oracle Corporation, a leading business software maker, initiated a $0.05 quarterly dividend in May 2009. Oracle’s annual $0.20 dividend amounts to about $1 billion, a relatively small amount compared with operating cash flow of $8 billion and another $9 billion in cash and cash equivalent assets on its balance sheet at the end of fiscal year 2009. An analyst who follows Oracle for institutional investors saw the Oracle announcement as a signal that the company is well positioned to ride out the downturn and also gain market share.
B. In mid 2009, Paris based Groupe Eurotunnel announced its first ever dividend after it completed a debt restructuring and received insurance proceeds resulting from a fire that had closed the Channel Tunnel. In a 2 June 2009 press release, Eurotunnel’s CEO said that this “marked a turning point for the company as its business has returned to the realm of normality,” as the company anticipated a return to profitability.
1. An individual investor pays taxes of 28 percent on the next dollar of dividend income and taxes of 15 percent on the next dollar of capital gains. Which would she prefer: $1 in dividends or $0.87 in capital gains?
2. Suppose the tax rate on capital gains is 20 percent for all investors but the tax rate on dividend income differs among investors. A share drops by 70 percent of the amount of the dividend, on average, when the share goes ex dividend. Assume that any appropriate corrections for equity market price movements on ex dividend days have been made. Calculate the marginal tax rate on dividend income applying to those who trade the issue around the ex dividend day.
3. Consider a U.S. corporation with a corporate income tax rate of 40 percent. The corporation needs to report as taxable income only 30 percent of dividends received from other corporations—that is, it takes a 70 percent deduction on that type of dividend income in calculating taxes owed. Assume that both capital gains and reported dividends (dividends net of any deductible amount) are taxed at 40 percent. What is $1 of dividends worth in terms of capital gains for such a corporate investor?
4. Explain why the ex dividend share price would be expected to drop by more than the amount of the dividend if such investors as the corporation described in question 3 are the marginal trader in the issue.
5. For a given share issue, the share price consistently drops by an amount very close to the amount of the dividend when the share goes ex dividend. Describe the marginal investor in the shares.
Boaz Company manufactures CH 21 through two processes: Mixing and Packaging. In July, the following costs were incurred.
Mixing
Packaging
Raw Materials used
$10,000
$24,000
Factory Labor costs
8,000
36,000
Manufacturing Overhead costs
12,000
54,000
Units completed at a cost of $21,000 in the Mixing Department are transferred to the Packaging Department. Units completed at a cost of $102,000 in the Packaging Department are transferred to Finished Goods. Journalize the assignment of these costs to the two processes and the transfer of units as appropriate.
Fernando Company manufactures pizza sauce through two production departments: Cooking and Canning. In each process, materials and conversion costs are incurred evenly throughout the process. For the month of April, the work in process accounts show the following debits.
The ledger of Molindo Company has the following work in process account.
Work in Process—Painting
5/1
Balance
3,590
5/31
Transferred out
?
5/31
Materials
5,160
5/31
Labor
2,740
5/31
Overhead
1,650
5/31
Balance
?
Production records show that there were 400 units in the beginning inventory, 30% complete, 1,100 units started, and 1,200 units transferred out. The beginning work in process had materials cost of $2,040 and conversion costs of $1,550.The units in ending inventory were 40% complete.
Materials are entered at the beginning of the painting process.
Instructions
(a) How many units are in process at May 31?
(b) What is the unit materials cost for May?
(c) What is the unit conversion cost for May?
(d) What is the total cost of units transferred out in May?
Douglas Manufacturing Company has two production departments: Cutting and Assembly. July 1 inventories are Raw Materials $4,200,Work in Process—Cutting $2,900,Work in Process—Assembly $10,600, and Finished Goods $31,000. During July, the following transactions occurred.
1. Purchased $62,500 of raw materials on account.
2. Incurred $56,000 of factory labor. (Credit Wages Payable.)
3. Incurred $70,000 of manufacturing overhead; $40,000 was paid and the remainder is unpaid.
4. Requisitioned materials for Cutting $15,700 and Assembly $8,900.
5. Used factory labor for Cutting $29,000 and Assembly $27,000.
6. Applied overhead at the rate of $15 per machine hour. Machine hours were Cutting 1,680 and Assembly 1,720.
7. Transferred goods costing $67,600 from the Cutting Department to the Assembly Department.
8. Transferred goods costing $134,900 from Assembly to Finished Goods.
9. Sold goods costing $150,000 for $200,000 on account.
In Ramirez Company, materials are entered at the beginning of each process. Work in process inventories, with the percentage of work done on conversion costs, and production data for its Sterilizing Department in selected months during 2010 are as follows.
Beginning Work in Process
Ending Work in Process
Month
Units
Conversion Cost%
Units Transferred Out
Units
Conversion Cost%
January
–0–
—
7,000
2,000
60
March
–0–
—
12,000
3,000
30
May
–0–
—
16,000
5,000
80
July
–0–
—
10,000
1,500
40
Instructions
(a) Compute the physical units for January and May.
(b) Compute the equivalent units of production for (1) materials and (2) conversion costs for each month.
The Blending Department of Hancock Company has the following cost and production data for the month of April.
Costs:
Work in process, April 1
Direct materials: 100% complete
$100,000
Conversion costs: 20% complete
70,000
Cost of work in process, April 1
$170,000
Costs incurred during production in April
Direct materials
$ 800,000
Conversion costs
362,000
Costs incurred in April
$1,162,000
Units transferred out totaled 14,000. Ending work in process was 1,000 units that are 100% complete as to materials and 40% complete as to conversion costs.
Instructions
(a) Compute the equivalent units of production for (1) materials and (2) conversion costs for the month of April.
(b) Compute the unit costs for the month.
(c) Determine the costs to be assigned to the units transferred out and in ending work in process.
The Polishing Department of Estaban Manufacturing Company has the following production and manufacturing cost data for September. Materials are entered at the beginning of the process.
Production: Beginning inventory 1,600 units that are 100% complete as to materials and 30% complete as to conversion costs; units started during the period are 18,400; ending inventory of 5,000 units 10% complete as to conversion costs.
Manufacturing costs: Beginning inventory costs, comprised of $20,000 of materials and $43,180 of conversion costs; materials costs added in Polishing during the month, $177,200; labor and overhead applied in Polishing during the month, $102,680 and $257,140, respectively.
Instructions
(a) Compute the equivalent units of production for materials and conversion costs for the month of September.
(b) Compute the unit costs for materials and conversion costs for the month.
(c) Determine the costs to be assigned to the units transferred out and in process.
The Welding Department of Batista Manufacturing Company has the following production and manufacturing cost data for February 2010. All materials are added at the beginning of the process.
Manufacturing Costs
Beginning work in process
Beginning work in process
15,000 units
Materials
$18,000
1/10 complete
Conversion costs
14,175
$32,175
Units transferred out
49,000
Materials
180,000
Units started
60,000
Labor
32,780
Ending work in process
26,000 units
Overhead
61,445
1/5 complete
Instructions
Prepare a production cost report for the Welding Department for the month of February.
Carmeli Instrument Inc. manufactures two products: missile range instruments and space pressure gauges. During January, 50 range instruments and 300 pressure gauges were produced, and overhead costs of $81,000 were incurred. An analysis of overhead costs reveals the following activities.
Activity
Cost Driver
Total Cost
1. Materials handling
Number of requisitions
$30,000
2. Machine setups
Number of setups
27,000
3. Quality inspections
Number of inspections
24,000
The cost driver volume for each product was as follows.
Cost Driver
Instruments
Gauges
Total
Number of requisitions
400
600
1,000
Number of setups
150
300
450
Number of inspections
200
400
600
Instructions
(a) Determine the overhead rate for each activity.
(b) Assign the manufacturing overhead costs for January to the two products using activity based costing.
(c) Write a memo to the president of Carmeli Instrument, explaining the benefits of activity based costing.
Oakenfeld Company manufactures a number of specialized machine parts. Part Bunkka 22 uses $35 of direct materials and $15 of direct labor per unit. Oakenfeld’s estimated manufacturing overhead is as follows:
Materials handling
$100,000
Machining
200,000
Factory supervision
150,000
Total
$450,000
Overhead is applied based on direct labor costs, which were estimated at $200,000.
Oakenfeld is considering adopting activity based costing.The cost drivers are estimated at:
Activity
Cost driver
Expected use
Materials handling
Weight of materials
50,000 pounds
Machining
Machine hours
20,000 hours
Factory supervision
Direct labor hours
12,000 hours
Instructions
(a) Compute the cost of 1,000 units of Bunkka 22 using the current traditional costing system.
(b) Compute the cost of 1,000 units of Bunkka 22 using the proposed activity based costing system.
Assume the 1,000 units use 2,500 pounds of materials, 500 machine hours, and 1,000 direct labor hours.
Kasten Company manufactures bowling balls through two processes: Molding and Packaging. In the Molding Department, the urethane, rubber, plastics, and other materials are molded into bowling balls. In the Packaging Department, the balls are placed in cartons and sent to the finished goods warehouse. All materials are entered at the beginning of each process.
Labor and manufacturing overhead are incurred uniformly throughout each process. Production and cost data for the Molding Department during June 2010 are presented below.
Production Data
June
Beginning work in process units
–0–
Units started into production
20,000
Ending work in process units
2,000
Percent complete—ending inventory
60%
Cost Data
Materials
$198,000
Labor
50,400
Overhead
112,800
Total
$361,200
Instructions
(a) Prepare a schedule showing physical units of production.
(b) Determine the equivalent units of production for materials and conversion costs.
(c) Compute the unit costs of production.
(d) Determine the costs to be assigned to the units transferred and in process for June.
(e) Prepare a production cost report for the Molding Department for the month of June.
Ortega Industries Inc. manufactures in separate processes furniture for homes. In each process, materials are entered at the beginning, and conversion costs are incurred uniformly. Production and cost data for the first process in making two products in two different manufacturing plants are as follows.
Cutting Department
Production Data—July
Plant 1 T12 Tables
Plant 2 C10 Chairs
Work in process units, July 1
–0–
–0–
Units started into production
20,000
16,000
Work in process units, July 31
3,000
500
Work in process percent complete
60
80
Cost Data—July
Work in process, July 1
$ –0–
$ –0–
Materials
380,000
288,000
Labor
234,400
125,900
Overhead
104,000
96,700
Total
$718,400
$510,600
Instructions
(a) For each plant:
(1) Compute the physical units of production.
(2) Compute equivalent units of production for materials and for conversion costs.
(3) Determine the unit costs of production.
(4) Show the assignment of costs to units transferred out and in process.
(b) Prepare the production cost report for Plant 1 for July 2010.
Fiedel Company manufactures its product, Vitadrink, through two manufacturing processes: Mixing and Packaging. All materials are entered at the beginning of each process. On October 1, 2010, inventories consisted of Raw Materials $26,000,Work in Process—Mixing $0, Work in Process—Packaging $250,000, and Finished Goods $289,000. The beginning inventory for Packaging consisted of 10,000 units that were 50% complete as to conversion costs and fully complete as to materials. During October, 50,000 units were started into production in the Mixing Department and the following transactions were completed.
1. Purchased $300,000 of raw materials on account.
2. Issued raw materials for production: Mixing $210,000 and Packaging $45,000.
3. Incurred labor costs of $248,900.
4. Used factory labor: Mixing $182,500 and Packaging $66,400.
5. Incurred $790,000 of manufacturing overhead on account.
6. Applied manufacturing overhead on the basis of $22 per machine hour. Machine hours were 28,000 in Mixing and 6,000 in Packaging.
7. Transferred 45,000 units from Mixing to Packaging at a cost of $979,000.
8. Transferred 53,000 units from Packaging to Finished Goods at a cost of $1,315,000.
9. Sold goods costing $1,604,000 for $2,500,000 on account.
Cavalier Company has several processing departments. Costs charged to the Assembly Department for November 2010 totaled $2,229,000 as follows.
Work in process, November 1
Materials
$69,000
Conversion costs
48,150
$ 117,150
Materials added
1,548,000
Labor
225,920
Overhead
337,930
Production records show that 35,000 units were in beginning work in process 30% complete as to conversion costs, 700,000 units were started into production, and 25,000 units were in ending work in process 40% complete as to conversion costs. Materials are entered at the beginning of each process.
Instructions
(a) Determine the equivalent units of production and the unit production costs for the Assembly Department.
(b) Determine the assignment of costs to goods transferred out and in process.
(c) Prepare a production cost report for the Assembly Department.
Chen Company manufactures basketballs. Materials are added at the beginning of the production process and conversion costs are incurred uniformly. Production and cost data for the month of July 2010 are as follows.
Production Data—Basketballs
Units
Percent Complete
Work in process units, July 1
500
60%
Units started into production
1,000
Work in process units, July 31
600
30%
Cost Data—Basketballs
Work in process, July 1
Materials
$750
Conversion costs
600
$1,350
Direct materials
2,400
Direct labor
1,580
Manufacturing overhead
1,060
Instructions
(a) Calculate the following.
(1) The equivalent units of production for materials and conversion.
(2) The unit costs of production for materials and conversion costs.
(3) The assignment of costs to units transferred out and in process at the end of the accounting period.
(b) Prepare a production cost report for the month of July for the basketballs.
Luther Processing Company uses a weighted average process costing system and manufactures a single product—a premium rug shampoo and cleaner. The manufacturing activity for the month of October has just been completed. A partially completed production cost report for the month of October for the mixing and cooking department is shown on.
Instructions
(a) Prepare a schedule that shows how the equivalent units were computed so that you can complete the “Quantities: Units accounted for” equivalent units section shown in the production cost report, and compute October unit costs.
(b) Complete the “Cost Reconciliation Schedule” part of the production cost report on.
LUTHER PROCESSING COMPANY Mixing and Cooking Department Production Cost Report For the Month Ended October 31
Pedro Morales and Associates, a C.P.A. firm, uses job order costing to capture the costs of its audit jobs. There were no audit jobs in process at the beginning of November. Listed below are data concerning the three audit jobs conducted during November.
Gonzalez
Navarro
Rojas
Direct materials
$600
$400
$200
Auditor labor costs
$5,400
$6,600
$3,375
Auditor hours
72
88
45
Overhead costs are applied to jobs on the basis of auditor hours, and the predetermined overhead rate is $55 per auditor hour. The Gonzalez job is the only incomplete job at the end of November. Actual overhead for the month was $12,000.
Instructions
(a) Determine the cost of each job.
(b) Indicate the balance of the Work in Process account at the end of November.
(c) Calculate the ending balance of the Manufacturing Overhead account for November.
Easy Decorating uses a job order costing system to collect the costs of its interior decorating business. Each client’s consultation is treated as a separate job. Overhead is applied to each job based on the number of decorator hours incurred. Listed below are data for the current year.
Budgeted overhead
$960,000
Actual overhead
$982,800
Budgeted decorator hours
40,000
Actual decorator hours
40,500
The company uses Operating Overhead in place of Manufacturing Overhead.
Instructions
(a) Compute the predetermined overhead rate.
(b) Prepare the entry to apply the overhead for the year.
(c) Determine whether the overhead was under or over applied and by how much.
Garcia Manufacturing uses a job order cost system and applies overhead to production on the basis of direct labor costs. On January 1, 2010, Job No. 50 was the only job in process.
The costs incurred prior to January 1 on this job were as follows: direct materials $20,000, direct labor $12,000, and manufacturing overhead $16,000. As of January 1, Job No. 49 had been completed at a cost of $90,000 and was part of finished goods inventory. There was a $15,000 balance in the Raw Materials Inventory account.
During the month of January, Garcia Manufacturing began production on Jobs 51 and 52, and completed Jobs 50 and 51. Jobs 49 and 50 were also sold on account during the month for $122,000 and $158,000, respectively. The following additional events occurred during the month.
1. Purchased additional raw materials of $90,000 on account.
2. Incurred factory labor costs of $65,000. Of this amount $16,000 related to employer payroll taxes.
3. Incurred manufacturing overhead costs as follows: indirect materials $17,000; indirect labor $15,000; depreciation expense $19,000, and various other manufacturing overhead costs on account $20,000.
4. Assigned direct materials and direct labor to jobs as follows.
Job No.
Direct Materials
Direct Labor
50
$10,000
$ 5,000
51
39,000
25,000
52
30,000
20,000
Instructions
(a) Calculate the predetermined overhead rate for 2010, assuming Garcia Manufacturing estimates total manufacturing overhead costs of $1,050,000, direct labor costs of $700,000, and direct labor hours of 20,000 for the year.
(b) Open job cost sheets for Jobs 50, 51, and 52. Enter the January 1 balances on the job cost sheet for Job No. 50.
(c) Prepare the journal entries to record the purchase of raw materials, the factory labor costs incurred, and the manufacturing overhead costs incurred during the month of January.
(d) Prepare the journal entries to record the assignment of direct materials, direct labor, and manufacturing overhead costs to production. In assigning manufacturing overhead costs, use the overhead rate calculated in (a). Post all costs to the job cost sheets as necessary.
(e) Total the job cost sheets for any job(s) completed during the month. Prepare the journal entry (or entries) to record the completion of any job(s) during the month.
(f) Prepare the journal entry (or entries) to record the sale of any job(s) during the month.
(g) What is the balance in the Finished Goods Inventory account at the end of the month? What does this balance consist of?
(h) What is the amount of over or underapplied overhead?
For the year ended December 31, 2010, the job cost sheets of DeVoe Company contained the following data.
Job Number
Explanation
Direct Materials
Direct Labor
Manufacturing Overhead
Total Costs
7640
Balance 1/1
$25,000
$24,000
$28,800
$ 77,800
Current year’s costs
30,000
36,000
43,200
109,200
7641
Balance 1/1
11,000
18,000
21,600
50,600
Current year’s costs
43,000
48,000
57,600
148,600
7642
Current year’s costs
48,000
55,000
66,000
169,000
Other data:
1. Raw materials inventory totaled $15,000 on January 1. During the year, $140,000 of raw materials were purchased on account.
2. Finished goods on January 1 consisted of Job No. 7638 for $87,000 and Job No. 7639 for $92,000.
3. Job No. 7640 and Job No. 7641 were completed during the year.
4. Job Nos. 7638, 7639, and 7641 were sold on account for $530,000.
5. Manufacturing overhead incurred on account totaled $120,000.
6. Other manufacturing overhead consisted of indirect materials $14,000, indirect labor $20,000, and depreciation on factory machinery $8,000.
Instructions
(a) Prove the agreement of Work in Process Inventory with job cost sheets pertaining to unfinished work. Hint: Use a single T account for Work in Process Inventory. Calculate each of the following, then post each to the T account: (1) beginning balance, (2) direct materials, (3) direct labor, (4) manufacturing overhead, and (5) completed jobs.
(b) Prepare the adjusting entry for manufacturing overhead, assuming the balance is allocated entirely to Cost of Goods Sold.
(c) Determine the gross profit to be reported for 2010.
Enos Inc. is a construction company specializing in custom patios.The patios are constructed of concrete, brick, fiberglass, and lumber, depending upon customer preference. On June 1, 2010, the general ledger for Enos Inc. contains the following data.
Raw Materials Inventory
$4,200
Manufacturing Overhead Applied
$32,640
Work in Process Inventory
$5,540
Manufacturing Overhead Incurred
$31,650
Subsidiary data for Work in Process Inventory on June 1 are as follows.
Job Cost Sheets
Customer Job
Fowler
Haines
Krantz
Cost Element
$ 600
$ 800
$ 900
Direct materials
320
540
580
Direct labor
400
675
725
Manufacturing overhead
$1,320
$2,015
$2,205
During June, raw materials purchased on account were $3,900, and all wages were paid.
Additional overhead costs consisted of depreciation on equipment $700 and miscellaneous costs of $400 incurred on account.
A summary of materials requisition slips and time tickets for June shows the following.
Customer Job
Materials Requisition Slips
Time Tickets
Fowler
$ 800
$ 450
Elgin
2,000
800
Haines
500
360
Krantz
1,300
1,600
Fowler
300
390
4,900
3,600
General use
1,500
1,200
$6,400
$4,800
Overhead was charged to jobs at the same rate of $1.25 per dollar of direct labor cost. The patios for customers Fowler, Haines, and Krantz were completed during June and sold for a total of $18,900. Each customer paid in full.
Instructions
(a) Journalize the June transactions: (i) for purchase of raw materials, factory labor costs incurred, and manufacturing overhead costs incurred; (ii) assignment of raw materials, labor, and overhead to production; and (iii) completion of jobs and sale of goods.
(b) Post the entries to Work in Process Inventory.
(c) Reconcile the balance in Work in Process Inventory with the costs of unfinished jobs.
(d) Prepare a cost of goods manufactured schedule for June.
Vargas Corporation’s fiscal year ends on November 30. The following accounts are found in its job order cost accounting system for the first month of the new fiscal year.
Raw Materials Inventory
Dec. 1
Beginning balance
(a)
Dec. 31
Requisitions
18,850
31
Purchases
19,225
Dec. 31
Ending balance
7,975
Work in Process Inventory
Dec. 1
Beginning balance
(b)
Dec. 31
Jobs completed
(f)
31
Direct materials
(c)
31
Direct labor
8,800
31
Overhead
(d)
Dec. 31
Ending balance
(e)
Finished Goods Inventory
Dec. 1
Beginning balance
(g)
Dec. 31
Cost of goods sold
(i)
31
Completed jobs
(h)
Dec. 31
Ending balance
(j)
Factory Labor
Dec. 31
Factory wages
12,465
Dec. 31
Wages assigned
(k)
Manufacturing Overhead
Dec. 31
Indirect materials
1,900
Dec. 31
Overhead applied
(m)
31
Indirect labor
(l)
31
Other overhead
1,245
Other data:
1. On December 1, two jobs were in process: Job No. 154 and Job No. 155.These jobs had combined direct materials costs of $9,750 and direct labor costs of $15,000. Overhead was applied at a rate that was 80% of direct labor cost.
2. During December, Job Nos. 156, 157, and 158 were started. On December 31, Job No. 158 was unfinished. This job had charges for direct materials $3,800 and direct labor $4,800, plus manufacturing overhead. All jobs, except for Job No. 158, were completed in December.
3. On December 1, Job No. 153 was in the finished goods warehouse. It had a total cost of $5,000. On December 31, Job No. 157 was the only job finished that was not sold. It had a cost of $4,000.
4. Manufacturing overhead was $230 overapplied in December.
Instructions
List the letters (a) through (m) and indicate the amount pertaining to each letter.
Weinrich Manufacturing uses a job order cost system and applies overhead to production on the basis of direct labor hours. On January 1, 2010, Job No. 25 was the only job in process.The costs incurred prior to January 1 on this job were as follows: direct materials $10,000; direct labor $6,000; and manufacturing overhead $9,000. Job No. 23 had been completed at a cost of $42,000 and was part of finished goods inventory. There was a $5,000 balance in the Raw Materials Inventory account.
During the month of January, the company began production on Jobs 26 and 27, and completed Jobs 25 and 26. Jobs 23 and 25 were sold on account during the month for $63,000 and $74,000, respectively. The following additional events occurred during the month.
1. Purchased additional raw materials of $40,000 on account.
2. Incurred factory labor costs of $31,500. Of this amount $7,500 related to employer payroll taxes.
3. Incurred manufacturing overhead costs as follows: indirect materials $10,000; indirect labor $7,500; depreciation Expense $12,000; and various other manufacturing overhead costs on account $11,000.
4. Assigned direct materials and direct labor to jobs as follows.
Job No.
Direct Materials
Direct Labor
25
$ 5,000
$ 3,000
26
17,000
12,000
27
13,000
9,000
5. The company uses direct labor hours as the activity base to assign overhead. Direct labor hours incurred on each job were as follows: Job No. 25, 200; Job No. 26, 800; and Job No. 27, 600.
Instructions
(a) Calculate the predetermined overhead rate for the year 2010, assuming Weinrich Manufacturing estimates total manufacturing overhead costs of $480,000, direct labor costs of $300,000, and direct labor hours of 20,000 for the year.
(b) Open job cost sheets for Jobs 25, 26, and 27. Enter the January 1 balances on the job cost sheet for Job No. 25.
(c) Prepare the journal entries to record the purchase of raw materials, the factory labor costs incurred, and the manufacturing overhead costs incurred during the month of January.
(d) Prepare the journal entries to record the assignment of direct materials, direct labor, and manufacturing overhead costs to production. In assigning manufacturing overhead costs, use the overhead rate calculated in (a). Post all costs to the job cost sheets as necessary.
(e) Total the job cost sheets for any job(s) completed during the month. Prepare the journal entry (or entries) to record the completion of any job(s) during the month.
(f) Prepare the journal entry (or entries) to record the sale of any job(s) during the month.
(g) What is the balance in the Work in Process Inventory account at the end of the month? What does this balance consist of?
(h) What is the amount of over or underapplied overhead?
For the year ended December 31, 2010, the job cost sheets of Moxie Company contained the following data.
Job Number
Explanation
Direct Materials
Direct Labor
Manufacturing Overhead
Total Costs
7650
Balance 1/1
$18,000
$20,000
$25,000
$ 63,000
Current year’s costs
32,000
36,000
45,000
113,000
7651
Balance 1/1
12,000
16,000
20,000
48,000
Current year’s costs
30,000
40,000
50,000
120,000
7652
Current year’s costs
45,000
68,000
85,000
198,000
Other data:
1. Raw materials inventory totaled $20,000 on January 1. During the year, $100,000 of raw materials were purchased on account.
2. Finished goods on January 1 consisted of Job No. 7648 for $93,000 and Job No. 7649 for $62,000.
3. Job No. 7650 and Job No. 7651 were completed during the year.
4. Job Nos. 7648, 7649, and 7650 were sold on account for $490,000.
5. Manufacturing overhead incurred on account totaled $135,000.
6. Other manufacturing overhead consisted of indirect materials $12,000, indirect labor $18,000 and depreciation on factory machinery $19,500.
Instructions
(A) Prove the agreement of Work in Process Inventory with job cost sheets pertaining to unfinished work. (Hint: Use a single T account for Work in Process Inventory.) Calculate each of the following, then post each to the T account: (1) beginning balance, (2) direct materials, (3) direct labor, (4) manufacturing overhead, and (5) completed jobs.
(b) Prepare the adjusting entry for manufacturing overhead, assuming the balance is allocated entirely to cost of goods sold.
(c) Determine the gross profit to be reported for 2010.
Michael Ortiz is a contractor specializing in custom built jacuzzis. On May 1, 2010, his ledger contains the following data.
Raw Materials Inventory
$30,000
Work in Process Inventory
12,200
Manufacturing Overhead
2,500 (dr.)
The Manufacturing Overhead account has debit totals of $12,500 and credit totals of $10,000. Subsidiary data for Work in Process Inventory on May 1 include:
Job Cost Sheets
Job
Manufacturing
by Customer
Direct Materials
Direct Labor
Overhead
Taylor
$2,500
$2,000
$1,400
Baker
2,000
1,200
840
Joiner
900
800
560
$5,400
$4,000
$2,800
During May, the following costs were incurred: (a) raw materials purchased on account $4,000, (b) labor paid $7,600, (c) manufacturing overhead paid $1,400. A summary of materials requisition slips and time tickets for the month of May reveals the following.
Job by Customer
Materials Requisition Slips
Time Tickets
Taylor
$ 500
$ 400
Baker
600
1,000
Joiner
2,300
1,300
Smith
1,900
2,900
General use
5,300
5,600
1,500
2,000
$6,800
$7,600
Overhead was charged to jobs on the basis of $0.70 per dollar of direct labor cost. The jacuzzis for customers Taylor, Baker, and Joiner were completed during May. Each jacuzzi was sold for $12,000 cash.
Instructions
(a) Prepare journal entries for the May transactions: (i) for purchase of raw materials, factory labor costs incurred, and manufacturing overhead costs incurred; (ii) assignment of raw materials, labor, and overhead to production; and (iii) completion of jobs and sale of goods.
(b) Post the entries to Work in Process Inventory.
(c) Reconcile the balance in Work in Process Inventory with the costs of unfinished jobs.
(d) Prepare a cost of goods manufactured schedule for May.
Elliott Manufacturing uses a job order cost system in each of its three manufacturing departments. Manufacturing overhead is applied to jobs on the basis of direct labor cost in Department A, direct labor hours in Department B, and machine hours in Department C. In establishing the predetermined overhead rates for 2010 the following estimates were made for the year.
Department
A
B
C
Manufacturing overhead
$780,000
$640,000
$750,000
Direct labor cost
$600,000
$100,000
$600,000
Direct labor hours
50,000
40,000
40,000
Machine hours
100,000
120,000
150,000
During January, the job cost sheets showed the following costs and production data.
Department
A
B
C
Direct materials used
$92,000
$86,000
$64,000
Direct labor cost
$48,000
$35,000
$50,400
Manufacturing overhead incurred
$66,000
$60,000
$62,100
Direct labor hours
4,000
3,500
4,200
Machine hours
8,000
10,500
12,600
Instructions
(a) Compute the predetermined overhead rate for each department.
(b) Compute the total manufacturing costs assigned to jobs in January in each department.
(c) Compute the under or overapplied overhead for each department at January 31.
Bell Company’s fiscal year ends on June 30. The following accounts are found in its job order cost accounting system for the first month of the new fiscal year.
Raw Materials Inventory
July 1
Beginning balance
19,000
July 31
Requisitions
(a)
31
Purchases
90,400
July 31
Ending balance
(b)
Work in Process Inventory
July 1
Beginning balance
(c)
July 31
Jobs completed
(f)
31
Direct materials
75,000
31
Direct labor
(d)
31
Overhead
(e)
July 31
Ending balance
(g)
Finished Goods Inventory
July 1
Beginning balance
(h)
July 31
Cost of goods sold
(j)
31
Completed jobs
(i)
July 31
Ending balance
(k)
Factory Labor
July 31
Factory wages
(l)
July 31
Wages assigned
(m)
Manufacturing Overhead
July 31
Indirect materials
8,900
July 31
Overhead applied
114,000
31
Indirect labor
16,000
31
Other overhead
(n)
Other data:
1. On July 1, two jobs were in process: Job No. 4085 and Job No. 4086, with costs of $19,000 and $13,200, respectively.
2. During July, Job Nos. 4087, 4088, and 4089 were started. On July 31, only Job No. 4089 was unfinished. This job had charges for direct materials $2,000 and direct labor $1,500, plus manufacturing overhead. Manufacturing overhead was applied at the rate of 120% of direct labor cost.
3. On July 1, Job No. 4084, costing $145,000, was in the finished goods warehouse. On July 31, Job No. 4088, costing $138,000, was in finished goods.
4. Overhead was $3,000 underapplied in July.
Instructions
List the letters (a) through (n) and indicate the amount pertaining to each letter. Show computations.
Pine Products Company uses a job order cost system. For a number of months there has been an ongoing rift between the sales department and the production department concerning a special order product,TC 1.TC 1 is a seasonal product that is manufactured in batches of 1,000 units. TC 1 is sold at cost plus a markup of 40% of cost.
The sales department is unhappy because fluctuating unit production costs significantly affect selling prices. Sales personnel complain that this has caused excessive customer complaints and the loss of considerable orders for TC 1. The production department maintains that each job order must be fully costed on the basis of the costs incurred during the period in which the goods are produced. Production personnel maintain that the only real solution to the problem is for the sales department to increase sales in the slack periods.
Regina Newell, president of the company, asks you as the company accountant to collect quarterly data for the past year on TC 1. From the cost accounting system, you accumulate the
Quarter
Costs
1
2
3
4
Direct materials
$100,000
$220,000
$ 80,000
$200,000
Direct labor
60,000
132,000
48,000
120,000
Manufacturing overhead
105,000
123,000
97,000
125,000
Total
$265,000
$475,000
$225,000
$445,000
Production in batches
5
11
4
10
Unit cost (per batch)
$ 53,000
$ 43,182
$ 56,250
$ 44,500
following production quantity and cost data.
Instructions
With the class divided into groups, answer the following questions.
(a) What manufacturing cost element is responsible for the fluctuating unit costs? Why?
(b) What is your recommended solution to the problem of fluctuating unit cost?
(c) Restate the quarterly data on the basis of your recommended solution.
In the course of routine checking of all journal entries prior to preparing yearend reports, Diane Riser discovered several strange entries. She recalled that the president’s son Ron had come in to help out during an especially busy time and that he had recorded some journal entries. She was relieved that there were only a few of his entries, and even more relieved that he had included rather lengthy explanations. The entries Ron made were:
(1)
Work in Process Inventory
25,000
Cash
25,000
(This is for materials put into process. I don’t find the record that we paid for these, so I’m crediting Cash, because I know we’ll have to pay for them sooner or later.)
(2)
Manufacturing Overhead
12000
Cash
12000
(This is for bonuses paid to salespeople. I know they’re part of overhead, and I can’t find an account called “Non factory Overhead” or “Other Overhead” so I’m putting it in Manufacturing Overhead. I have the check stubs, so I know we paid these.)
(3)
Wages Expense
120000
Cash
120000
(This is for the factory workers’ wages. I have a note that payroll taxes are $15,000. I still think that’s part of wages expense, and that we’ll have to pay it all in cash sooner or later, so I credited Cash for the wages and the taxes.)
(4)
Work in Process Inventory
3000
Raw Materials Inventory
3000
(This is for the glue used in the factory. I know we used this to make the products, even though we didn’t use very much on any one of the products. I got it out of inventory, so I credited an inventory account.)
Instructions
(a) How should Ron have recorded each of the four events?
(b) If the entry was not corrected, which financial statements (income statement or balance sheet) would be affected? What balances would be overstated or understated?
You are the management accountant for Newberry Manufacturing. Your company does custom carpentry work and uses a job order cost accounting system. Newberry sends detailed job cost sheets to its customers, along with an invoice. The job cost sheets show the date materials were used, the dollar cost of materials, and the hours and cost of labor.
A predetermined overhead application rate is used, and the total overhead applied is also listed.
Donna Werly is a customer who recently had custom cabinets installed. Along with her check in payment for the work done, she included a letter. She thanked the company for including the detailed cost information but questioned why overhead was estimated. She stated that she would be interested in knowing exactly what costs were included in overhead, and she thought that other customers would, too.
Instructions
Prepare a letter to Ms. Werly (address: 123 Cedar Lane, Altoona, Kansas 66651) and tell her why you did not send her information on exact costs of overhead included in her job. Respond to her suggestion that you provide this information.
SEK Printing provides printing services to many different corporate clients. Although SEK bids most jobs, some jobs, particularly new ones, are negotiated on a “cost plus” basis. Cost plus means that the buyer is willing to pay the actual cost plus a return (profit) on these costs to SEK.
Betty Keiser, controller for SEK, has recently returned from a meeting where SEK’s president stated that he wanted her to find a way to charge most costs to any project that was on a cost plus basis. The president noted that the company needed more profits to meet its stated goals this period. By charging more costs to the cost plus projects and therefore fewer costs to the jobs that were bid, the company should be able to increase its profit for the current year.
Betty knew why the president wanted to take this action. Rumors were that he was looking for a new position and if the company reported strong profit, the president’s opportunities would be enhanced. Betty also recognized that she could probably increase the cost of certain jobs by changing the basis used to allocate manufacturing overhead.
Instructions
(a) Who are the stakeholders in this situation?
(b) What are the ethical issues in this situation?
Essence Company manufactures a high end after shave lotion, called Eternity, in 10 ounce plastic bottles. Because the market for after shave lotion is highly competitive, the company is very concerned about keeping its costs under control. Eternity is manufactured through three processes: mixing, filling, and corking. Materials are added at the beginning of each of the processes, and labor and overhead are incurred uniformly throughout each process. The company uses a weighted average method to cost its product. A partially completed production cost report for the month of May for the Mixing Department is shown below.
ESSENCE COMPANY Mixing Department Production Cost Report For the Month Ended May 31, 2010
Equivalent Units
QUANTITIES
Physical Units
Materials
Conversion Costs
Units to be accounted for
Step 1
Step 2
Work in process, May 1
1,000
Started into production
2,000
Total units
3,000
Units accounted for
Transferred out
2,200
?
?
Work in process, May 31
800
?
?
Total units
3,000
?
?
COSTS
Materials
Conversion Costs
Total
Unit costs Step 3
Costs in May
(a)
?
?
?
Equivalent units
(b)
?
?
Unit costs [(a) (b)]
?
?
?
Costs to be accounted for
Work in process, May 1
$ 56,300
Started into production
119,320
Total costs
$175,620
COST RECONCILIATION SCHEDULE Step 4
Costs accounted for
Transferred out
?
Work in process, May 31
Materials
?
Conversion costs
?
Total costs
Additional information:
Work in process, May 1, 1000 units
Materials cost, 1,000 units (100% complete)
$49,100
Conversion costs, 1,000 units (70% complete)
7,200
$56,300
Materials cost for May, 2,000 units
$100,000
Conversion costs for May
$19,320
Work in process, May 31, 800 units, 100% complete as to materials and 50%
complete as to conversion costs.
Instructions
(a) Prepare a production cost report for the Mixing Department for the month of May.
(b) Prepare the journal entry to record the transfer of goods from the Mixing Department to the Filling Department.
(c) Explain why Essence Company is using a process cost system to account for its costs.
Ernie Els has formulated the following list of statements about contemporary developments in managerial accounting.
1. Just in time processing results in a push approach; that is, raw materials are pushed through each process.
2. A primary objective of just in time processing is to eliminate all manufacturing inventories.
3. A major disadvantage of just in time processing is lower product quality.
4. A primary benefit of activity based costing is more accurate and meaningful product costing.
5. A major advantage of activity based costing is that it uses a single unit level basis, such as direct labor or machine hours, to allocate overhead. Identify each statement as true or false. If false, indicate how to correct the statement to make it true.
In 2007 Sprint Nextel Corporation reported a large goodwill impairment loss. Referring to Sprint Nextel’s 2007 financial statements and applicable financial reporting standards, answer the following questions:
1. How much goodwill impairment charge did Sprint Nextel report in 2007?
2. Why did Sprint Nextel write down their goodwill in 2007? What are some other indicators for goodwill impairment in general?
3. How did Sprint Nextel reflect this impairment in financial statements?
4. How often does Sprint Nextel test its goodwill for impairment and what are the testing steps?
5. Certain other indefinite lived intangibles and other long lived assets (including intangible assets with a finite life) are also subject to impairment assessment. Did Sprint Nextel incur any of these impairment charges in 2007? Explain briefly when and how Sprint Nextel tests these assets for impairment.
6. Is impairment of goodwill and other intangible assets reversible under U.S. GAAP? How about under IFRS? (Refer to FASB Topic 350 Intangibles—Goodwill and Other, and IAS 36 Impairment of Assets)
7. Is goodwill impaired in the same way under IFRS? Does IFRS also employ a two step approach for goodwill impairment testing? If not, how is goodwill tested for impairment under IFRS?
In July 2001, the FASB issued SFAS 142, which changed the accounting for goodwill and intangible assets. Upon adoption of SFAS 142, many companies recognized large goodwill impairment losses. For example, in 2002, AOL Time Warner (now Time Warner) recorded a $99 billion reduction in the carrying value of its goodwill—still one of the largest goodwill impairments. The SFAS 142 requirements continue under ASC Topic 350, Intangibles—Goodwill and Other. Use the AOL Time Warner, Inc., 2002 SEC Form 10 K Annual Report and SFAS 142 to address the following issues and questions.
Required
1. How did AOL determine the initial amount of goodwill to recognize in its merger with Time Warner?
2. How did AOL Time Warner determine the $99 billion 2002 impairment charge to its goodwill? What procedures will Time Warner follow in the future to assess the value of its goodwill?
3. What business areas did AOL Time Warner designate as its reporting units? Why is it important to define the reporting units?
4. What effects did SFAS 142 have on AOL Time Warner’s earnings performance both in the short term and in the long term?
5. What is the rationale behind the accounting treatment for goodwill (initial recognition and subsequent allocation to income)?
On January 1, 2010, Innovus, Inc., acquired 100 percent of the common stock of ChipTech Company for $670,000 in cash and other fair value consideration. ChipTech’s fair value was allocated among its net assets as follows:
Fair value of consideration transferred for ChipTech
$670,000
Book value of ChipTech:
Common stock and APIC
$130,000
Retained earnings
370,000
500,000
Excess fair value over book value to
170,000
Trademark (10 year remaining life)
40,000
Existing technology (5 year remaining life)
80,000
120,000
Goodwill
$50,000
The December 31, 2011, trial balances for the parent and subsidiary follow:
Innovus
ChipTech
Revenues
($990,000)
($210,000)
Cost of goods sold
500,000
90,000
Depreciation expense
100,000
5,000
Amortization expense
55,000
18,000
Dividend income
40,000
–0–
Net income
($375,000)
($97,000)
Retained earnings 1/1/11
($1,555,000)
($450,000)
Net income
375,000
97,000
Dividends paid
250,000
40,000
Retained earnings 12/31/11
($1,680,000)
($507,000)
Current assets
$960,000
$355,000
Investment in ChipTech
670,000
Equipment (net)
765,000
225,000
Trademark
235,000
100,000
Existing technology
–0–
45,000
Goodwill
450,000
–0–
Total assets
$3,080,000
$725,000
Liabilities
($780,000)
88,000
Common stock
500,000
100,000
Additional paid in capital
120,000
30,000
Retained earnings 12/31/11
1,680,000
507,000
Total liabilities and equity
($3,080,000)
($725,000)
Required
a. Using Excel, compute consolidated balances for Innovus and ChipTech. Either use a worksheet approach or compute the balances directly.
b. Prepare a second spreadsheet that shows a 2011 impairment loss for the entire amount of goodwill from the ChipTech acquisition.
On January 1, 2009, Father Company acquired an 80 percent interest in Sun Company for $425,000. The acquisition date fair value of the 20 percent noncontrolling interest’s ownership shares was $102,500. Also as of that date, Sun reported total stockholders’ equity of $400,000:
$100,000 in common stock and $300,000 in retained earnings. In setting the acquisition price, Father appraised four accounts at values different from the balances reported within Sun’s financial records.
Buildings (8 year life)
Undervalued by $20,000
Land
Undervalued by $50,000
Equipment (5 year life)
Undervalued by $12,500
Royalty agreement (20 year life)
Not recorded, valued at $30,000
As of December 31, 2013, the trial balances of these two companies are as follows:
Father Company
Sun Company
Debits
Current assets
$605,000
$280,000
Investment in Sun Company
425,000
–0–
Land
200,000
300,000
Buildings (net)
640,000
290,000
Equipment (net)
380,000
160,000
Expenses
550,000
190,000
Dividends
90,000
20,000
Total debits
$2,890,000
$1,240,000
Credits
Liabilities
$910,000
$300,000
Common stock
480,000
100,000
Retained earnings, 1/1/13
704,000
480,000
Revenues
780,000
360,000
Dividend income
16,000
–0–
Total credits
$2,890,000
$1,240,000
Included in these figures is a $20,000 debt that Sun owes to the parent company. No goodwill impairments have occurred since the Sun Company acquisition.
Required
a. Determine consolidated totals for Father Company and Sun Company for the year 2013.
b. Prepare worksheet entries to consolidate the trial balances of Father Company and Sun Company for the year 2013.
c. Assume instead that the acquisition date fair value of the noncontrolling interest was $112,500. What balances in the December 31, 2013, consolidated statements would change?
James Company acquired 85 percent of Mark Right Company on April 1. On its December 31 consolidated income statement, how should James account for Mark Right’s revenues and expenses that occurred before April 1?
a. Include 100 percent of Mark Right’s revenues and expenses and deduct the preacquisition portion as noncontrolling interest in net income.
b. Exclude 100 percent of the preacquisition revenues and 100 percent of the preacquisition expenses from their respective consolidated totals.
c. Exclude 15 percent of the preacquisition revenues and 15 percent of the preacquisition expenses from consolidated expenses.
d. Deduct 15 percent of the net combined revenues and expenses relating to the preacquisition period from consolidated net income.
Amie, Inc., has 100,000 shares of $2 par value stock outstanding. Prairie Corporation acquired 30,000 of Amie’s shares on January 1, 2009, for $120,000 when Amie’s net assets had a total fair value of $350,000. On July 1, 2012, Prairie agreed to buy an additional 60,000 shares of Amie from a single stockholder for $6 per share. Although Amie’s shares were selling in the $5 range around July 1, 2012, Prairie forecasted that obtaining control of Amie would produce significant revenue synergies to justify the premium price paid. If Amie’s net identifiable assets had a fair value of $500,000 at July 1, 2012, how much goodwill should Prairie report in its postcombination consolidated balance sheet?
West Company acquired 60 percent of Solar Company for $300,000 when Solar’s book value was $400,000. The newly comprised 40 percent noncontrolling interest had an assessed fair value of $200,000. Also at the acquisition date, Solar had a trademark (with a 10 year life) that was undervalued in the financial records by $60,000. Also, patented technology (with a 5 year life) was undervalued by $40,000. Two years later, the following figures are reported by these two companies (stockholders’ equity accounts have been omitted):
On January 1, Park Corporation and Strand Corporation had condensed balance sheets as follows:
Park
Strand
Current assets
$70,000
$20,000
Noncurrent assets
90,000
40,000
Total assets
$160,000
$60,000
Current liabilities
$30,000
$10,000
Long term debt
50,000
—
Stockholders’ equity
80,000
50,000
Total liabilities and equities
$160,000
$60,000
On January 2, Park borrowed $60,000 and used the proceeds to obtain 80 percent of the outstanding common shares of Strand. The acquisition price was considered proportionate to Strand’s total fair value. The $60,000 debt is payable in 10 equal annual principal payments, plus interest, beginning December 31. The excess fair value of the investment over the underlying book value of the acquired net assets is allocated to inventory (60 percent) and to goodwill (40 percent). On a consolidated balance sheet as of January 2, what should be the amount for each of the following?
Cinta Company is a manufacturer of toys. Its controller resigned in August 2010. An inexperienced assistant accountant has prepared the following income statement for the month of August 2010.
CINTA COMPANY Income Statement For the Month Ended August 31, 2010
Sales (net)
$675,000
Less: Operating expenses
Raw materials purchases
$220,000
Direct labor cost
160,000
Advertising expense
75,000
Selling and administrative salaries
70,000
Rent on factory facilities
60,000
Depreciation on sales equipment
50,000
Depreciation on factory equipment
35,000
Indirect labor cost
20,000
Utilities expense
10,000
Insurance expense
5,000
705,000
Net loss
$(30,000)
Prior to August 2010 the company had been profitable every month. The company’s president is concerned about the accuracy of the income statement. As her friend, you have been asked to review the income statement and make necessary corrections. After examining other manufacturing cost data, you have acquired additional information as follows.
1. Inventory balances at the beginning and end of August were:
August 1
August 31
Raw materials
$19,500
$30,000
Work in process
25,000
21,000
Finished goods
40,000
59,000
2. Only 50% of the utilities expense and 70% of the insurance expense apply to factory operations; the remaining amounts should be charged to selling and administrative activities.
Instructions
(a) Prepare a cost of goods manufactured schedule for August 2010.
(b) Prepare a correct income statement for August 2010.
Waterways Corporation is a private corporation formed for the purpose of providing the products and the services needed to irrigate farms, parks, commercial projects, and private lawns. It has a centrally located factory in a U.S. city that manufactures the products it markets to retail outlets across the nation. It also maintains a division that provides installation and warranty servicing in six metropolitan areas.
The mission of Waterways is to manufacture quality parts that can be used for effective irrigation projects that also conserve water. By that effort, the company hopes to satisfy its customers, provide rapid and responsible service, and serve the community and the employees who represent them in each community.
The company has been growing rapidly, so management is considering new ideas to help the company continue its growth and maintain the high quality of its products. Waterways was founded by Will Winkman, who is the company president and chief executive officer(CEO).Working with him from the company’s inception was Will’s brother, Ben, whose sprinkler designs and ideas about the installation of proper systems have been a major basis of the company’s success. Ben is the vice president who oversees all aspects of design and production in the company.
The factory itself is managed by Todd Senter who hires his line managers to supervise the factory employees. The factory makes all of the parts for the irrigation systems. The purchasing department is managed by Hector Hines. The installation and training division is overseen by vice president Henry Writer, who supervises the managers of the six local installation operations. Each of these local managers hires his or her own local service people.These service employees are trained by the home office under Henry Writer’s direction because of the uniqueness of the company’s products.
There is a small human resources department under the direction of Sally Fenton, a vice president who handles the employee paperwork, though hiring is actually performed by the separate departments. Sam Totter is the vice president who heads the sales and marketing area; he oversees 10 well trained salespeople.
The accounting and finance division of the company is headed by Abe Headman, who is the chief financial officer (CFO) and a company vice president; he is a member of the Institute of Management Accountants and holds a certificate in management accounting. He has a small staff of Certified Public Accountants, including a controller and a treasurer, and a staff of accounting input operators who maintain the financial records.
Love All is a fairly large manufacturing company located in the southern United States. The company manufactures tennis rackets, tennis balls, tennis clothing, and tennis shoes, all bearing the company’s distinctive logo, a large green question mark on a white flocked tennis
ball. The company’s sales have been increasing over the past 10 years. The tennis racket division has recently implemented several advanced manufacturing techniques. Robot arms hold the tennis rackets in place while glue dries, and machine vision systems check for defects. The engineering and design team uses computerized drafting and testing of new products. The following managers work in the tennis racket division.
Andre Agassi, Sales Manager (supervises all sales representatives).
Pete Sampras, cost accounting manager (supervises cost accountants).
Andy Roddick, production supervisor (supervises all manufacturing employees). Venus Williams, engineer (supervises all new product design teams).
Instructions
(a) What are the primary information needs of each manager?
(b) Which, if any, financial accounting report(s) is each likely to use?
(c) Name one special purpose management accounting report that could be designed for each manager. Include the name of the report, the information it would contain, and how frequently it should be issued.
Wayne Terrago, controller for Robbin Industries, was reviewing production cost reports for the year. One amount in these reports continued to bother him—advertising.
During the year, the company had instituted an expensive advertising campaign to sell some of its slower moving products. It was still too early to tell whether the advertising campaign was successful.
There had been much internal debate as how to report advertising cost. The vice president of finance argued that advertising costs should be reported as a cost of production, just like direct materials and direct labor. He therefore recommended that this cost be identified as manufacturing overhead and reported as part of inventory costs until sold. Others disagreed.
Terrago believed that this cost should be reported as an expense of the current period, based on the conservatism principle. Others argued that it should be reported as Prepaid Advertising and reported as a current asset.
The president finally had to decide the issue. He argued that these costs should be reported as inventory. His arguments were practical ones. He noted that the company was experiencing financial difficulty and expensing this amount in the current period might jeopardize a planned bond offering. Also, by reporting the advertising costs as inventory rather than as prepaid advertising, less attention would be directed to it by the financial community.
Instructions
(a) Who are the stakeholders in this situation?
(b) What are the ethical issues involved in this situation?
During February, Cardella Manufacturing works on two jobs: A16 and B17. Summary data concerning these jobs are as follows. Manufacturing Overhead Cardella Manufacturing uses a predetermined overhead rate with direct labor costs as the activity base. It expects annual overhead costs to be $760,000 and direct labor costs for the year to be $950,000.
Manufacturing Costs Incurred
Purchased $54,000 of raw materials on account.
Factory labor $76,000, plus $4,000 employer payroll taxes.
Manufacturing overhead exclusive of indirect materials and indirect labor $59,800.
Assignment of Costs
Direct materials:
Job A16 $27,000, Job B17 $21,000
Indirect materials:
$3,000
Direct labor:
Job A16 $52,000, Job B17 $26,000
Indirect labor:
$2,000
Job A16 was completed and sold on account for $150,000. Job B17 was only partially completed.
Instructions
(a) Compute the predetermined overhead rate.
(b) Journalize the February transactions in the sequence followed in the chapter.
(c) What was the amount of under or overapplied manufacturing overhead?
Milner Manufacturing uses a job order cost accounting system. On May 1, the company has a balance in Work in Process Inventory of $3,200 and two jobs in process: Job No. 429 $ 2,000, and Job No. 430 $1,200. During May, a summary of source documents reveals the following.
Job Number
Materials Requisition Slips
Labor Time Tickets
429
$2,500
$1,900
430
3,500
3,000
431
4,400
$10,400
7,600
$12,500
General use
800
1,200
$11,200
$13,700
Milner Manufacturing applies manufacturing overhead to jobs at an overhead rate of 80% of direct labor cost. Job No. 429 is completed during the month.
Instructions
(a) Prepare summary journal entries on May 31 to record: (i) the requisition slips, (ii) the time tickets, (iii) the assignment of manufacturing overhead to jobs, and (iv) the completion of Job No. 429.
(b) Post the entries to Work in Process Inventory, and prove the agreement of the control account with the job cost sheets of the unfinished jobs.
Manufacturing cost data for Pena Company, which uses a job order cost system, are presented below.
Case A
Case B
Case C
Direct materials used
$ (a)
$ 83,000
$ 63,150
Direct labor
50,000
120,000
(h)
Manufacturing overhead applied
42,500
(d)
(i)
Total manufacturing costs
155,650
(e)
213,000
Work in process 1/1/10
(b)
15,500
18,000
Total cost of work in process
201,500
(f)
(j)
Work in process 12/31/10
(c)
11,800
(k)
Cost of goods manufactured
192,300
(g)
222,000
Instructions
Indicate the missing amount for each letter. Assume that in all cases manufacturing overhead is applied on the basis of direct labor cost and the rate is the same.
Elder Corporation incurred the following transactions.
1. Purchased raw materials on account $46,300.
2. Raw Materials of $36,000 were requisitioned to the factory. An analysis of the materials requisition slips indicated that $6,800 was classified as indirect materials.
3. Factory labor costs incurred were $53,900, of which $49,000 pertained to factory wages payable and $4,900 pertained to employer payroll taxes payable.
4. Time tickets indicated that $48,000 was direct labor and $5,900 was indirect labor.
5. Overhead costs incurred on account were $80,500.
6. Manufacturing overhead was applied at the rate of 150% of direct labor cost.
7. Goods costing $88,000 were completed and transferred to finished goods.
8. Finished goods costing $75,000 to manufacture were sold on account for $103,000.
Instructions
Journalize the transactions. (Omit explanations.)
Job Number
Materials
Factory Labor
A20
$ 35,240
$18,000
A21
42,920
22,000
A22
36,100
15,000
A23
39,270
25,000
General factory use
4,470
7,300
$158,000
$87,300
3. Manufacturing overhead costs incurred on account $39,500.
4. Depreciation on machinery and equipment $14,550.
5. Manufacturing overhead rate is 80% of direct labor cost.
6. Jobs completed during the quarter: A20, A21, and A23.
Instructions
Prepare entries to record the operations summarized above. (Prepare a schedule showing the individual cost elements and total cost for each job in item 6.)
Tomlin Company begins operations on April 1. Information from job cost sheets shows the following.
Manufacturing Costs Assigned
Job Number
April
May
June
Month Completed
10
$5,200
$4,400
May
11
4,100
3,900
$3,000
June
12
1,200
April
13
4,700
4,500
June
14
4,900
3,600
Not complete
Job 12 was completed in April. Job 10 was completed in May. Jobs 11 and 13 were completed in June. Each job was sold for 25% above its cost in the month following completion.
Instructions
(a) What is the balance in Work in Process Inventory at the end of each month?
(b) What is the balance in Finished Goods Inventory at the end of each month?
(c) What is the gross profit for May, June, and July?
Dosmann, Inc., bought all outstanding shares of Lizzi Corporation on January 1, 2011, for $700,000 in cash. This portion of the consideration transferred results in a fair value allocation of $35,000 to equipment and goodwill of $88,000. At the acquisition date, Dosmann also agrees to pay Lizzi’s previous owners an additional $110,000 on January 1, 2013, if Lizzi earns a 10 percent return on the fair value of its assets in 2011 and 2012. Lizzi’s profits exceed this threshold in both years. Which of the following is true?
a. The additional $110,000 payment is a reduction in consolidated retained earnings.
b. The fair value of the expected contingent payment increases goodwill at the acquisition date.
c. Consolidated goodwill as of January 1, 2013, increases by $110,000.
d. The $110,000 is recorded as an expense in 2013.
Kaplan Corporation acquired Star, Inc., on January 1, 2011, by issuing 13,000 shares of common stock with a $10 per share par value and a $23 market value. This transaction resulted in recognizing $62,000 of goodwill. Kaplan also agreed to compensate Star’s former owners for any difference if Kaplan’s stock is worth less than $23 on January 1, 2012. On January 1, 2012, Kaplan issues an additional 3,000 shares to Star’s former owners to honor the contingent consideration agreement. Which of the following is true?
a. The fair value of the number of shares issued for the contingency increases the Goodwill account balance at January 1, 2012.
b. The parent’s additional paid in capital from the contingent equity recorded at the acquisition date is reclassified as a regular common stock issue on January 1, 2012.
c. All of the subsidiary’s asset and liability accounts must be revalued for consolidation purposes based on their fair values as of January 1, 2012.
d. The additional shares are assumed to have been issued on January 1, 2011, so that a retrospective adjustment is required.
Herbert, Inc., acquired all of Rambis Company’s outstanding stock on January 1, 2011, for $574,000 in cash. Annual excess amortization of $12,000 results from this transaction. On the date of the takeover, Herbert reported retained earnings of $400,000, and Rambis reported a $200,000 balance. Herbert reported internal income of $40,000 in 2011 and $50,000 in 2012 and paid $10,000 in dividends each year. Rambis reported net income of $20,000 in 2011 and $30,000 in 2012 and paid $5,000 in dividends each year.
a. Assume that Herbert’s internal income figures above do not include any income from the subsidiary.
• If the parent uses the equity method, what is the amount reported as consolidated retained earnings on December 31, 2012?
• Would the amount of consolidated retained earnings change if the parent had applied either the initial value or partial equity method for internal accounting purposes?
b. Under each of the following situations, what is the Investment in Rambis account balance on Herbert’s books on January 1, 2012?
• The parent uses the equity method.
• The parent uses the partial equity method.
• The parent uses the initial value method.
c. Under each of the following situations, what is Entry *C on a 2012 consolidation worksheet?
Haynes, Inc., obtained 100 percent of Turner Company’s common stock on January 1, 2011, by issuing 9,000 shares of $10 par value common stock. Haynes’s shares had a $15 per share fair value. On that date, Turner reported a net book value of $100,000. However, its equipment (with a five year remaining life) was undervalued by $5,000 in the company’s accounting records. Also, Turner had developed a customer list with an assessed value of $30,000, although no value had been recorded on Turner’s books. The customer list had an estimated remaining useful life of 10 years. The following figures come from the individual accounting records of these two companies as of December 31, 2011:
Haynes
Turner
Revenues
($600,000)
($230,000)
Expenses
440,000
120,000
Investment income
Not given
–0–
Dividends paid
80,000
50,000
The following figures come from the individual accounting records of these two companies as of December 31, 2012:
Haynes
Turner
Revenues
($700,000)
($280,000)
Expenses
460,000
150,000
Investment income
Not given
–0–
Dividends paid
90,000
40,000
Equipment
500,000
300,000
a. What balance does Haynes’s Investment in Turner account show on December 31, 2012, when the equity method is applied?
b. What is the consolidated net income for the year ending December 31, 2012?
c. What is the consolidated equipment balance as of December 31, 2012? How would this answer be affected by the investment method applied by the parent?
d. If Haynes has applied the initial value method to account for its investment, what adjustment is needed to the beginning of the Retained Earnings on a December 31, 2012, consolidation worksheet? How would this answer change if the partial equity method had been in use? How would this answer change if the equity method had been in use?
Francisco Inc. acquired 100 percent of the outstanding voting shares of Beltran Company on January 1, 2011. To obtain these shares, Francisco payed $450,000 in cash and issued 104,000 shares of its own $1 par value common stock. On this date, Francisco’s stock had a fair value of $12 per share. The combination is a statutory merger with Beltran subsequently dissolved as a legal corporation. For internal accountability purposes, Beltran’s assets and liabilities are assigned to a new reporting unit. The following reports the fair values for the Beltran reporting unit for January 1, 2011, and December 31, 2012, along with their respective book values on December 31, 2012.
Beltran Reporting Unit
Fair Values 1/1/11
Fair Values 12/31/12
Book Values 12/31/12
Cash
$75,000
$50,000
$50,000
Receivables
193,000
225,000
225,000
Inventory
281,000
305,000
300,000
Patents
525,000
600,000
500,000
Customer relationships
500,000
480,000
450,000
Equipment (net)
295,000
240,000
235,000
Goodwill
?
?
400,000
Accounts payable
121,000
175,000
175,000
Long term liabilities
450,000
400,000
400,000
a. Prepare Francisco’s journal entry to record the assets acquired and the liabilities assumed in the Beltran merger on January 1, 2011.
b. On December 31, 2012, Francisco estimates that the total fair value of the entire Beltran reporting unit is $1,425,000. What amount of goodwill impairment, if any, should Francisco recognize on its 2012 income statement?
Acme Co., a consolidated enterprise, conducted an impairment review for each of its reporting units. One particular reporting unit, Martel, emerged as a candidate for possible goodwill impairment. Martel has recognized net assets of $780, including goodwill of $500. Martel’s fair value is assessed at $650 and includes two internally developed unrecognized intangible assets (a patent and a customer list with fair values of $150 and $50, respectively). The following table summarizes current financial information for the Martel reporting unit:
Carrying Amounts
Fair Values
Tangible assets, net
$80
$110
Recognized intangible assets, net
200
230
Goodwill
500
?
Unrecognized intangible assets
–0–
200
Total
$780
$650
a. Show the two steps to determine the amount of any goodwill impairment for Acme’s Martel reporting unit.
b. After recognition of any goodwill impairment loss, what are the reported book values for the following assets of Acme’s reporting unit Martel?
Destin Company recently acquired several businesses and recognized goodwill in each acquisition. Destin has allocated the resulting goodwill to its three reporting units: Sand Dollar, Salty Dog, and Baytowne. In its annual review for goodwill impairment, Destin provides the following individual asset and liability values for each reporting unit:
Carrying Values
Fair Values
Sand Dollar
Tangible assets
$180,000
$190,000
Trademark
170,000
150,000
Customer list
90,000
100,000
Goodwill
120,000
?
Liabilities
30,000
30,000
Salty Dog
Tangible assets
$200,000
$200,000
Unpatented technology
170,000
125,000
Licenses
90,000
100,000
Goodwill
150,000
?
Baytowne
Tangible assets
140,000
150,000
Unpatented technology
–0–
100,000
Copyrights
50,000
80,000
Goodwill
90,000
?
The overall valuations for the entire reporting units (including goodwill) are $510,000 for Sand Dollar, $580,000 for Salty Dog, and $560,000 for Baytowne. To date, Destin has reported no goodwill impairments.
a. Which of Destin’s reporting units require both steps to test for goodwill impairment?
b. How much goodwill impairment should Destin report this year?
c. What changes to the valuations of Destin’s tangible assets and identified intangible assets should be reported based on the goodwill impairment tests?
Chapman Company obtains 100 percent of Abernethy Company’s stock on January 1, 2011. As of that date, Abernethy has the following trial balance:
Debit
Credit
Accounts payable
$50,000
Accounts receivable
$40,000
Additional paid in capital
50,000
Buildings (net) (4 year life)
120,000
Cash and short term investments
60,000
Common stock
250,000
Equipment (net) (5 year life)
200,000
Inventory
90,000
Land
80,000
Long term liabilities (mature 12/31/14)
150,000
Retained earnings, 1/1/11
100,000
Supplies
10,000
Totals
$600,000
$600,000
During 2011, Abernethy reported income of $80,000 while paying dividends of $10,000. During 2012, Abernethy reported income of $110,000 while paying dividends of $30,000.
Adams, Inc., acquires Clay Corporation on January 1, 2010, in exchange for $510,000 cash. Immediately after the acquisition, the two companies have the following account balances. Clay’s equipment (with a five year life) is actually worth $440,000. Credit balances are indicated by parentheses.
Adams
Clay
Current assets
$300,000
$220,000
Investment in Clay
510,000
–0–
Equipment
600,000
390,000
Liabilities
200,000
160,000
Common stock
350,000
150,000
Retained earnings, 1/1/10
860,000
300,000
In 2010, Clay earns a net income of $55,000 and pays a $5,000 cash dividend. In 2010, Adams reports income from its own operations (exclusive of any income from Clay) of $125,000 and declares no dividends. At the end of 2011, selected account balances for the two companies are as follows:
Adams
Clay
Revenues
($400,000)
($240,000)
Expenses
290,000
180,000
Investment income
Not given
–0–
Retained earnings, 1/1/11
Not given
350,000
Dividends declared
0
8,000
Common stock
350,000
150,000
Current assets
580,000
262,000
Investment in Clay
Not given
–0–
Equipment
520,000
420,000
Liabilities
152,000
130,000
a. What are the December 31, 2011, Investment Income and Investment in Clay account balances assuming Adams uses the:
1. Initial value method.
2. Equity method.
b. How does the parent’s internal investment accounting method choice affect the amount reported for expenses in its December 31, 2011, consolidated income statement?
c. How does the parent’s internal investment accounting method choice affect the amount reported for equipment in its December 31, 2011, consolidated balance sheet?
d. What is Adams’s January 1, 2011, Retained Earnings account balance assuming Adams accounts for its investment in Clay using the:
1. Initial value method.
2. Equity method.
e. What worksheet adjustment to Adams’s January 1, 2011, Retained Earnings account balance is required if Adams accounts for its investment in Clay using the initial value method?
f. Prepare the worksheet entry to eliminate Clay’s stockholders’ equity.
Following are selected account balances from Penske Company and Stanza Corporation as of December 31, 2012:
Penske
Stanza
Revenues
($700,000)
($400,000)
Cost of goods sold
250,000
100,000
Depreciation expense
150,000
200,000
Investment income
Not given
–0–
Dividends paid
80,000
60,000
Retained earnings, 1/1/12
600,000
200,000
Current assets
400,000
500,000
Copyrights
900,000
400,000
Royalty agreements
600,000
1,000,000
Investment in Stanza
Not given
–0–
Liabilities
500,000
1,380,000
Common stock
(600,000) ($20 par)
(200,000) ($10 par)
Additional paid in capital
150,000
80,000
On January 1, 2012, Penske acquired all of Stanza’s outstanding stock for $680,000 fair value in cash and common stock. Penske also paid $10,000 in stock issuance costs. At the date of acquisition copyrights (with a six year remaining life) have a $440,000 book value but a fair value of $560,000.
a. As of December 31, 2012, what is the consolidated copyrights balance?
b. For the year ending December 31, 2012, what is consolidated Net Income?
c. As of December 31, 2012, what is the consolidated Retained Earnings balance?
d. As of December 31, 2012, what is the consolidated balance to be reported for goodwill?
Foxx Corporation acquired all of Greenburg Company’s outstanding stock on January 1, 2011, for $600,000 cash. Greenburg’s accounting records showed net assets on that date of $470,000, although equipment with a 10 year life was undervalued on the records by $90,000. Any recognized goodwill is considered to have an indefinite life. Greenburg reports net income in 2011 of $90,000 and $100,000 in 2012. The subsidiary paid dividends of $20,000 in each of these two years. Financial figures for the year ending December 31, 2013, follow. Credit balances are indicated by parentheses.
Foxx
Greenburg
Revenues
($800,000)
($600,000)
Cost of goods sold
100,000
150,000
Depreciation expense
300,000
350,000
Investment income
20,000
–0–
Net income
($420,000)
($100,000)
Retained earnings, 1/1/13
($1,100,000)
($320,000)
Net income
420,000
100,000
Dividends paid
120,000
20,000
Retained earnings, 12/31/13
($1,400,000)
($400,000)
Current assets
$300,000
$100,000
Investment in subsidiary
600,000
–0–
Equipment (net)
900,000
600,000
Buildings (net)
800,000
400,000
Land
600,000
100,000
Total assets
$3,200,000
$1,200,000
Liabilities
($900,000)
($500,000)
Common stock
900,000
300,000
Retained earnings
1,400,000
400,000
Total liabilities and equity
($3,200,000)
($1,200,000)
a. Determine the December 31, 2013, consolidated balance for each of the following accounts:
Depreciation Expense
Buildings
Dividends Paid
Goodwill
Revenues
Common Stock
Equipment
b. How does the parent’s choice of an accounting method for its investment affect the balances computed in requirement (a)?
c. Which method of accounting for this subsidiary is the parent actually using for internal reporting purposes?
d. If the parent company had used a different method of accounting for this investment, how could that method have been identified?
e. What would be Foxx’s balance for retained earnings as of January 1, 2013, if each of the following methods had been in use?
Patrick Corporation acquired 100 percent of O’Brien Company’s outstanding common stock on January 1, for $550,000 in cash. O’Brien reported net assets with a carrying value of $350,000 at that time. Some of O’Brien’s assets either were unrecorded (having been internally developed) or had fair values that differed from book values as follows:
Book Values
Fair Values
Trademarks (indefinite life)
$60,000
$160,000
Customer relationships (5 year life)
–0–
75,000
Equipment (10 year life)
342,000
312,000
Any goodwill is considered to have an indefinite life with no impairment charges during the year. Following are financial statements at the end of the first year for these two companies prepared from their separately maintained accounting systems. Credit balances are indicated by parentheses.
Patrick
O’Brien
Revenues
($1,125,000)
($520,000)
Cost of goods sold
300,000
228,000
Depreciation expense
75,000
70,000
Amortization expense
25,000
–0–
Income from O’Brien
210,000
–0–
Net Income
($935,000)
($222,000)
Retained earnings 1/1
700,000
250,000
Net Income
935,000
222,000
Dividends paid
142,000
80,000
Retained earnings 12/31
($1,493,000)
($392,000)
Cash
$185,000
$105,000
Receivables
225,000
56,000
Inventory
175,000
135,000
Investment in O’Brien
680,000
–0–
Trademarks
474,000
60,000
Customer relationships
–0–
–0–
Equipment (net)
925,000
272,000
Goodwill
–0–
–0–
Total assets
$2,664,000
$628,000
Liabilities
771,000
136,000
Common stock
400,000
100,000
Retained earnings 12/31
1,493,000
392,000
Total liabilities and equity
($2,664,000)
($628,000)
a. Show how Patrick computed the $210,000 Income of O’Brien balance. Discuss how you determined which accounting method Patrick uses for its investment in O’Brien.
b. Without preparing a worksheet or consolidation entries, determine and explain the totals to be reported for this business combination for the year ending December 31.
c. Verify the totals determined in part (b) by producing a consolidation worksheet for Patrick and O’Brien for the year ending December 31.
Following are separate financial statements of Michael Company and Aaron Company as of December 31, 2013 (credit balances indicated by parentheses). Michael acquired all of Aaron’s outstanding voting stock on January 1, 2009, by issuing 20,000 shares of its own $1 par common stock. On the acquisition date, Michael Company’s stock actively traded at $23.50 per share.
Company 12/31/13
Company 12/31/13
Revenues
($610,000)
($370,000)
Cost of goods sold
270,000
140,000
Amortizations expense
115,000
80,000
Dividend income
5,000
–0–
Net income
($230,000)
($150,000)
Retained earnings, 1/1/13
($880,000)
($490,000)
Net income (above)
230,000
150,000
Dividends paid
90,000
5,000
Retained earnings, 12/31/13
($1,020,000)
($635,000)
Cash
$110,000
$15,000
Receivables
380,000
220,000
Inventory
560,000
280,000
Investment in Aaron Company
470,000
–0–
Copyrights
460,000
340,000
Royalty agreements
920,000
380,000
Total assets
$2,900,000
$1,235,000
Liabilities
($780,000)
($470,000)
Preferred stock
300,000
–0–
Common stock
500,000
100,000
Additional paid in capital
300,000
30,000
Retained earnings, 12/31/13.
1,020,000
635,000
Total liabilities and equity
($2,900,000)
($1,235,000)
On the date of acquisition, Aaron reported retained earnings of $230,000 and a total book value of $360,000. At that time, its royalty agreements were undervalued by $60,000. This intangible was assumed to have a six year life with no residual value. Additionally, Aaron owned a trademark with a fair value of $50,000 and a 10 year remaining life that was not reflected on its books.
a. Using the preceding information, prepare a consolidation worksheet for these two companies as of December 31, 2013.
b. Assuming that Michael applied the equity method to this investment, what account balances would differ on the parent’s individual financial statements?
c. Assuming that Michael applied the equity method to this investment, what changes would be necessary in the consolidation entries found on a December 31, 2013, worksheet?
d. Assuming that Michael applied the equity method to this investment, what changes would be created in the consolidated figures to be reported by this combination?
Giant acquired all of Small’s common stock on January 1, 2009. Over the next few years, Giant applied the equity method to the recording of this investment. At the date of the original acquisition, $90,000 of the fair value price was attributed to undervalued land while $50,000 was assigned to equipment having a 10 year life. The remaining $60,000 unallocated portion of the acquisition date excess fair value over book value was viewed as goodwill. Following are individual financial statements for the year ending December 31, 2013. On that date, Small owes Giant $10,000. Credits are indicated by parentheses.
a. How was the $135,000 Equity in Income of Small balance computed?
b. Without preparing a worksheet or consolidation entries, determine and explain the totals to be reported by this business combination for the year ending December 31, 2013.
Giant
Small
Revenues
($1,175,000)
($360,000)
Cost of goods sold
550,000
90,000
Depreciation expense
172,000
130,000
Equity in income of Small
135,000
–0–
Net income
($588,000)
($140,000)
Retained earnings, 1/1/13
($1,417,000)
($620,000)
Net income (above)
588,000
140,000
Dividends paid
310,000
110,000
Retained earnings, 12/31/13
($1,695,000)
($650,000)
Current assets
$398,000
$318,000
Investment in Small
995,000
–0–
Land
440,000
165,000
Buildings (net)
304,000
419,000
Equipment (net)
648,000
286,000
Goodwill
–0–
–0–
Total assets
$2,785,000
$1,188,000
Liabilities
($840,000)
($368,000)
Common stock
250,000
170,000
Retained earnings (above)
1,695,000
650,000
Total liabilities and equity
($2,785,000)
($1,188,000)
c. Verify the figures determined in part (b) by producing a consolidation worksheet for Giant and Small for the year ending December 31, 2013.
d. If Giant determined that the entire amount of goodwill from its investment in Small was impaired in 2013, how would the parent’s accounts reflect the impairment loss? How would the worksheet process change? What impact does an impairment loss have on consolidated financial statements?
On January 1, 2011, Peterson Corporation exchanged $1,090,000 fair value consideration for all of the outstanding voting stock of Santiago, Inc. At the acquisition date, Santiago had a book value equal to $950,000. Santiago’s individual assets and liabilities had fair values equal to their respective book values except for the patented technology account, which was undervalued by $240,000 with an estimated remaining life of six years. The Santiago acquisition was Peterson’s only business combination for the year. In case expected synergies did not materialize, Peterson Corporation wished to prepare for a potential future spin off of Santiago, Inc. Therefore, Peterson had Santiago maintain its separate incorporation and independent accounting information system as elements of continuing value. On December 31, 2011 each company submitted the following financial statements for consolidation.
Peterson Corp.
Santiago, Inc.
Income Statement
Revenues
535,000
495,000
Cost of goods sold
170,000
155,000
Gain on bargain purchase
100,000
–0–
Depreciation and amortization
125,000
140,000
Equity earnings from Santiago
160,000
–0–
Net income
500,000
200,000
Statement of Retained Earnings
Retained earnings, 1/1
1,500,000
650,000
Net income (above)
500,000
200,000
Dividends paid
200,000
50,000
Retained earnings, 12/31
1,800,000
800,000
Balance Sheet
Current assets
190,000
300,000
Investment in Santiago
1,300,000
–0–
Trademarks
100,000
200,000
Patented technology
300,000
400,000
Equipment
610,000
300,000
Total assets
2,500,000
1,200,000
Liabilities
165,000
100,000
Common stock
535,000
300,000
Retained earnings, 12/31
1,800,000
800,000
Total liabilities and equity
2,500,000
1,200,000
a. Show how Peterson determined the following account balances
• Gain on bargain purchase
• Earnings from Santiago
• Investment in Santiago
b. Prepare a December 31, 2011, consolidated worksheet for Peterson and Santiago.
Palm Company acquired 100 percent of Storm Company’s voting stock on January 1, 2009, by issuing 10,000 shares of its $10 par value common stock (having a fair value of $14 per share). As of that date, Storm had stockholders’ equity totaling $105,000. Land shown on Storm’s accounting records was undervalued by $10,000. Equipment (with a five year life) was undervalued by $5,000. A secret formula developed by Storm was appraised at $20,000 with an estimated life of 20 years. Following are the separate financial statements for the two companies for the year ending December 31, 2013. Credit balances are indicated by parentheses.
Palm Company
Storm Company
Revenues
($485,000)
($190,000)
Cost of goods sold
160,000
70,000
Depreciation expense
130,000
52,000
Subsidiary earnings
66,000
–0–
Net income
($261,000)
($68,000)
Retained earnings, 1/1/13
($659,000)
($98,000)
Net income (above)
261,000
68,000
Dividends paid
175,500
40,000
Retained earnings, 12/31/13
($744,500)
($126,000)
Current assets
$268,000
$75,000
Investment in Storm Company
216,000
–0–
Land
427,500
58,000
Buildings and equipment (net)
713,000
161,000
Total assets
$1,624,500
$294,000
Current liabilities
($110,000)
($19,000)
Long term liabilities
80,000
84,000
Common stock
600,000
60,000
Additional paid in capital
90,000
5,000
Retained earnings, 12/31/13
744,500
126,000
Total liabilities and equity
($1,624,500)
($294,000)
a. Explain how Palm derived the $66,000 balance in the Subsidiary Earnings account.
b. Prepare a worksheet to consolidate the financial information for these two companies.
c. Explain how Storm’s individual financial records would differ if the push down method of accounting had been applied.
Tyler Company acquired all of Jasmine Company’s outstanding stock on January 1, 2009, for $206,000 in cash. Jasmine had a book value of only $140,000 on that date. However, equipment (having an eightyear life) was undervalued by $54,400 on Jasmine’s financial records. A building with a 20 year life was overvalued by $10,000. Subsequent to the acquisition, Jasmine reported the following:
Net Income
Dividends Paid
2009
$50,000
$10,000
2010
60,000
40,000
2011
30,000
20,000
In accounting for this investment, Tyler has used the equity method. Selected accounts taken
from the financial records of these two companies as of December 31, 2011, follow:
Tyler Company
Jasmine Company
Revenues—operating
($310,000)
($104,000)
Expenses
198,000
74,000
Equipment (net)
320,000
50,000
Buildings (net)
220,000
68,000
Common stock
290,000
50,000
Retained earnings, 12/31/11 balance
410,000
160,000
Determine and explain the following account balances as of December 31, 2011:
a. Investment in Jasmine Company (on Tyler’s individual financial records).
b. Equity in Subsidiary Earnings (on Tyler’s individual financial records).
On January 1, 2010, Picante Corporation acquired 100 percent of the outstanding voting stock of Salsa Corporation for $1,765,000 cash. On the acquisition date, Salsa had the following balance sheet:
Cash
$14,000
Accounts payable
$120,000
Accounts receivable
100,000
Long term debt
930,000
Land
700,000
Common stock
1,000,000
Equipment (net)
1,886,000
Retained earnings
650,000
$2,700,000
$2,700,000
At the acquisition date, the following allocation was prepared:
Fair value of consideration transferred
$1,765,000
Book value acquired
1,650,000
Excess fair value over book value
115,000
To in process research and development
$44,000
To equipment (8 yr. remaining life) .
56,000
100,000
To goodwill (indefinite life)
$15,000
Although at acquisition date Picante had expected $44,000 in future benefits from Salsa’s inprocess research and development project, by the end of 2010, it was apparent that the research project was a failure with no future economic benefits. On December 31, 2011, Picante and Salsa submitted the following trial balances for consolidation:
Picante
Salsa
Sales
($3,500,000)
($1,000,000)
Cost of goods sold
1,600,000
630,000
Depreciation expense
540,000
160,000
Subsidiary income
03,000
–0–
Net income
($1,563,000)
($210,000)
Retained earnings 1/1/11
($3,000,000)
($800,000)
Net income
1,563,000
210,000
Dividends paid
200,000
25,000
Retained earnings 12/31/11
($4,363,000)
($985,000)
Cash
$228,000
$50,000
Accounts receivable
840,000
155,000
Inventory
900,000
580,000
Investment in Salsa
2,042,000
–0–
Land
3,500,000
700,000
Equipment (net)
5,000,000
1,700,000
Goodwill
290,000
–0–
Total assets
$12,800,000
$3,185,000
Accounts payable
($193,000)
($400,000)
Long term debt
3,094,000
800,000
Common stock
5,150,000
1,000,000
Retained earnings 12/31/11
4,363,000
985,000
Total liabilities and equities .
($12,800,000)
($3,185,000)
a. Show how Picante derived its December 31, 2011, Investment in Salsa account balance.
b. Prepare a consolidated worksheet for Picante and Salsa as of December 31, 2011.
On January 1, Prine, Inc., acquired 100 percent of Lydia Company’s common stock for a fair value of $120,000,000 in cash and stock. Lydia’s assets and liabilities equaled their fair values except for its equipment, which was undervalued by $500,000 and had a 10 year remaining life. Prine specializes in media distribution and viewed its acquisition of Lydia as a strategic move into content ownership and creation. Prine expected both cost and revenue synergies from controlling Lydia’s artistic content (a large library of classic movies) and its sports programming specialty video operation. Accordingly, Prine allocated Lydia’s assets and liabilities (including $50,000,000 of goodwill) to a newly formed operating segment appropriately designated as a reporting unit. The fair values of the reporting unit’s identifiable assets and liabilities through the first year of operations were as follows.
Fair Values
Account
1 Jan
31 Dec
Cash
$215,000
$109,000
Receivables (net)
525,000
897,000
Movie library (25 year life)
40,000,000
60,000,000
Broadcast licenses (indefinite life)
15,000,000
20,000,000
Equipment (10 year life)
20,750,000
19,000,000
Current liabilities
490,000
650,000
Long term debt
6,000,000
6,250,000
However, Lydia’s assets have taken longer than anticipated to produce the expected synergies with Prine’s operations. At year end, Prine reduced its assessment of the Lydia reporting unit’s fair value to $110,000,000. At December 31, Prine and Lydia submitted the following balances for consolidation:
Prine, Inc.
Lydia Co.
Revenues
($18,000,000)
($12,000,000)
Operating expenses
10,350,000
11,800,000
Equity in Lydia earnings
150,000
NA
Dividends paid
300,000
80,000
Retained earnings, 1/1
52,000,000
2,000,000
Cash
260,000
109,000
Receivables (net)
210,000
897,000
Investment in Lydia
120,070,000
NA
Broadcast licenses
350,000
14,014,000
Movie library
365,000
45,000,000
Equipment (net)
136,000,000
17,500,000
Current liabilities
755,000
650,000
Long term debt
22,000,000
7,250,000
Common stock
175,000,000
67,500,000
a. What is the relevant initial test to determine whether goodwill could be impaired?
b. At what amount should Prine record an impairment loss for its Lydia reporting unit for the year?
c. What is consolidated net income for the year?
d. What is the December 31 consolidated balance for goodwill?
e. What is the December 31 consolidated balance for broadcast licenses?
f. Prepare a consolidated worksheet for Prine and Lydia (Prine’s trial balance should first be adjusted for any appropriate impairment loss).
Jonas Tech Corporation recently acquired Innovation + Company. The combined firm consists of three related businesses that will serve as reporting units. In connection with the acquisition, Jonas requests your help with the following asset valuation and allocation issues. Support your answers with references to FASB standards as appropriate. Jonas recognizes several identifiable intangibles from its acquisition of Innovation _. It expresses the desire to have these intangible assets written down to zero in the acquisition period. The price Jonas paid for Innovation + indicates that it paid a large amount for goodwill. However, Jonas worries that any future goodwill impairment may send the wrong signal to its investors about the wisdom of the Innovation + acquisition. Jonas thus wishes to allocate the combined goodwill of all of its reporting units to one account called Enterprise Goodwill. In this way, Jonas hopes to minimize the possibility of goodwill impairment because a decline in goodwill in one business unit could be offset by an increase in the value of goodwill in another business unit.
Required
1. Advise Jonas on the acceptability of its suggested immediate write off of its identifiable intangibles.
2. Indicate the relevant factors to consider in allocating the value assigned to identifiable intangibles acquired in a business combination to expense over time.
3. Advise Jonas on the acceptability of its suggested treatment of goodwill.
4. Indicate the relevant factors to consider in allocating goodwill across an enterprise’s business units.
Consolidated financial reporting is appropriate when one entity has a controlling financial interest in another entity. The usual condition for a controlling financial interest is ownership of a majority voting interest. But in some circumstances, control does not rest with the majority owner—especially when minority owners are contractually provided with approval or veto rights that can restrict the actions of the majority owner. In these cases, the majority owner employs the equity method rather than consolidation.
Required
Address the following by searching the FASB ASC Topic 810 on consolidation.
1. What are protective minority rights?
2. What are substantive participating minority rights?
3. What minority rights overcome the presumption that all majority owned investees should be consolidated?
4. Zee Company buys 60 percent of the voting stock of Bee Company with the remaining 40 percent minority interest held by Bee’s former owners, who negotiated the following minority rights:
• Any new debt above $1,000,000 must be approved by the 40 percent minority shareholders.
• Any dividends or other cash distributions to owners in excess of customary historical amounts must be approved by the 40 percent minority shareholders.
According to the FASB ASC, what are the issues in determining whether Zee should consolidate Bee or report its investment in Bee under the equity method?
When negotiating a business acquisition, buyers sometimes agree to pay extra amounts to sellers in the future if performance metrics are achieved over specified time horizons. How should buyers account for such contingent consideration in recording an acquisition?
a. The amount ultimately paid under the contingent consideration agreement is added to goodwill when and if the performance metrics are met.
b. The fair value of the contingent consideration is expensed immediately at acquisition date.
c. The fair value of the contingent consideration is included in the overall fair value of the consideration transferred, and a liability or additional owners’ equity is recognized.
d. The fair value of the contingent consideration is recorded as a reduction of the otherwise determinable fair value of the acquired firm.
On June 1, Cline Co. paid $800,000 cash for all of the issued and outstanding common stock of Renn Corp. The carrying values for Renn’s assets and liabilities on June 1 follow:
Cash
$150,000
Accounts receivable
180,000
Capitalized software costs.
320,000
Goodwill
100,000
Liabilities
130,000
Net assets
$620,000
On June 1, Renn’s accounts receivable had a fair value of $140,000. Additionally, Renn’s inprocess research and development was estimated to have a fair value of $200,000. All other items were stated at their fair values. On Cline’s June 1 consolidated balance sheet, how much is reported for goodwill?
Prior to being united in a business combination, Atkins, Inc., and Waterson Corporation had the following stockholders’ equity figures:
Atkins
Waterson
Common stock ($1 par value)
$180,000
$45,000
Additional paid in capital
90,000
20,000
Retained earnings
300,000
110,000
Atkins issues 51,000 new shares of its common stock valued at $3 per share for all of the outstanding stock of Waterson. Assume that Atkins acquires Waterson. Immediately afterward, what are consolidated Additional Paid In Capital and Retained Earnings, respectively?
a. $104,000 and $300,000.
b. $110,000 and $410,000.
c. $192,000 and $300,000.
d. $212,000 and $410,000.
Hill, Inc., obtains control over Loring, Inc., on July 1. The book value and fair value of Loring’s accounts on that date (prior to creating the combination) follow, along with the book value of Hill’s accounts:
The following book and fair values were available for Westmont Company as of March 1.
Book Value
Fair Value
Inventory
$630,000
$600,000
Land
750,000
990,000
Buildings
1,700,000
2,000,000
Customer relationships
–0–
800,000
Accounts payable
80,000
80,000
Common stock
2,000,000
Additional paid in capital
500,000
Retained earnings 1/1
360,000
Revenues
420,000
Expenses
280,000
Arturo Company pays $4,000,000 cash and issues 20,000 shares of its $2 par value common stock (fair value of $50 per share) for all of Westmont’s common stock in a merger, after which Westmont will cease to exist as a separate entity. Stock issue costs amount to $25,000 and Arturo pays $42,000 for legal fees to complete the transaction. Prepare Arturo’s journal entry to record its acquisition of Westmont;
Following are preacquisition financial balances for Padre Company and Sol Company as of December 31. Also included are fair values for Sol Company accounts.
Sol Company
Padre Company Book Values 12/31
Book Values 12/31
Fair Values 12/31
Cash
$400,000
$120,000
$120,000
Receivables
220,000
300,000
300,000
Inventory
410,000
210,000
260,000
Land
600,000
130,000
110,000
Building and equipment (net)
600,000
270,000
330,000
Franchise agreements
220,000
190,000
220,000
Accounts payable
300,000
120,000
120,000
Accrued expenses
90,000
30,000
30,000
Long term liabilities
900,000
510,000
510,000
Common stock—$20 par value
660,000
Common stock—$5 par value
210,000
Additional paid in capital
70,000
90,000
Retained earnings, 1/1
390,000
240,000
Revenues
960,000
330,000
Expenses
920,000
310,000
On December 31, Padre acquires Sol’s outstanding stock by paying $360,000 in cash and issuing 10,000 shares of its own common stock with a fair value of $40 per share. Padre paid legal and accounting fees of $20,000 as well as $5,000 in stock issuance costs. Determine the value that would be shown in Padre and Sol’s consolidated financial statements for each of the accounts listed.
On June 30, 2011, Wisconsin, Inc., issued $300,000 in debt and 15,000 new shares of its $10 par value stock to Badger Company owners in exchange for all of the outstanding shares of that company. Wisconsin shares had a fair value of $40 per share. Prior to the combination, the financial statements for Wisconsin and Badger for the six month period ending June 30, 2011, were as follows:
Wisconsin
Badger
Revenues
($900,000)
($300,000)
Expenses
660,000
200,000
Net income
($240,000)
($100,000)
Retained earnings, 1/1
($800,000)
($200,000)
Net income
240,000
100,000
Dividends paid
90,000
–0–
Retained earnings, 6/30
($950,000)
($300,000)
Cash
$80,000
$110,000
Receivables and inventory
400,000
170,000
Patented technology (net)
900,000
300,000
Equipment (net)
700,000
600,000
Total assets
$2,080,000
$1,180,000
Liabilities
($500,000)
($410,000)
Common stock
360,000
200,000
Additional paid in capital
270,000
270,000
Retained earnings
950,000
300,000
Total liabilities and equities
($2,080,000)
($1,180,000)
Wisconsin also paid $30,000 to a broker for arranging the transaction. In addition, Wisconsin paid $40,000 in stock issuance costs. Badger’s equipment was actually worth $700,000, but its patented technology was valued at only $280,000. What are the consolidated balances for the following accounts?
On January 1, 2011, Pinnacle Corporation exchanged $3,200,000 cash for 100 percent of the outstanding voting stock of Strata Corporation. Pinnacle plans to maintain Strata as a wholly owned subsidiary with separate legal status and accounting information systems. At the acquisition date, Pinnacle prepared the following fair value allocation schedule:
Fair value of Strata (consideration transferred)
$3,200,000
Carrying amount acquired
2,600,000
Excess fair value
$600,000
to buildings (undervalued)
$300,000
to licensing agreements (overvalued)
100,000
200,000
to goodwill (indefinite life)
$400,000
Immediately after closing the transaction, Pinnacle and Strata prepared the following post acquisition balance sheets from their separate financial records.
Pinnacle
Strata
Cash
$433,000
$122,000
Accounts receivable
1,210,000
283,000
Inventory
1,235,000
350,000
Investment in Strata
3,200,000
–0–
Buildings (net)
5,572,000
1,845,000
Licensing agreements
–0–
3,000,000
Goodwill
350,000
–0–
Total Assets
$12,000,000
$5,600,000
Accounts payable
300,000
375,000
Long term debt
2,700,000
2,625,000
Common stock
3,000,000
1,000,000
APIC
–0–
500,000
Retained earnings
6,000,000
1,100,000
Total liabilities and equities
($12,000,000)
($5,600,000)
Prepare a January 1, 2011, consolidated balance sheet for Pinnacle Corporation and its subsidiary Strata Corporation.
On January 1, 2011, Marshall Company acquired 100 percent of the outstanding common stock of Tucker Company. To acquire these shares, Marshall issued $200,000 in long term liabilities and 20,000 shares of common stock having a par value of $1 per share but a fair value of $10 per share.
Marshall paid $30,000 to accountants, lawyers, and brokers for assistance in the acquisition and another $12,000 in connection with stock issuance costs. Prior to these transactions, the balance sheets for the two companies were as follows:
Marshall Company Book Value
Tucker Company Book Value
Cash
$60,000
$20,000
Receivables
270,000
90,000
Inventory
360,000
140,000
Land
200,000
180,000
Buildings (net)
420,000
220,000
Equipment (net)
$160,000
$50,000
Accounts payable
150,000
40,000
Long term liabilities
430,000
200,000
Common stock—$1 par value
110,000
Common stock—$20 par value
120,000
Additional paid in capital
360,000
–0–
Retained earnings, 1/1/11
420,000
340,000
In Marshall’s appraisal of Tucker, it deemed three accounts to be undervalued on the subsidiary’s books: Inventory by $5,000, Land by $20,000, and Buildings by $30,000. Marshall plans to maintain Tucker’s separate legal identity and to operate Tucker as a wholly owned subsidiary.
a. Determine the amounts that Marshall Company would report in its postacquisition balance sheet. In preparing the postacquisition balance sheet, any required adjustments to income accounts from the acquisition should be closed to Marshall’s retained earnings.
b. To verify the answers found in part (a), prepare a worksheet to consolidate the balance sheets of these two companies as of January 2011.
Pratt Company acquired all of Spider, Inc.’s outstanding shares on December 31, 2011, for $495,000 cash. Pratt will operate Spider as a wholly owned subsidiary with a separate legal and accounting identity. Although many of Spider’s book values approximate fair values, several of its accounts have fair values that differ from book values. In addition, Spider has internally developed assets that remain unrecorded on its books. In deriving the acquisition price, Pratt assessed Spider’s fair and book value differences as follows:
Book Values
Fair Values
Computer software
$20,000
$70,000
Equipment
40,000
30,000
Client contracts
–0–
100,000
In process research and development
–0–
40,000
Notes payable
60,000
65,000
At December 31, 2011, the following financial information is available for consolidation:
Allerton Company acquires all Deluxe Company’s assets and liabilities for cash on January 1, 2011, and subsequently formally dissolves Deluxe. At the acquisition date, the following book and fair values were available for the Deluxe Company accounts:
Book Values
Fair Values
Current assets
$60,000
$60,000
Building
90,000
50,000
Land
10,000
20,000
Trademark
–0–
30,000
Goodwill
15,000
?
Liabilities
40,000
40,000
Common stock
100,000
Retained earnings
35,000
Using the acquisition method, prepare Allerton’s entry to record its acquisition of Deluxe in its accounting records assuming the following cash exchange amounts:
On June 30, 2011, Sampras Company reported the following account balances:
Receivables
$80,000
Inventory
70,000
Buildings (net)
75,000
Equipment (net)
25,000
Total assets
$250,000
Current liabilities
($10,000)
Long term liabilities
50,000
Common stock
90,000
Retained earnings
100,000
Total liabilities and equities
($250,000)
On June 30, 2011, Pelham paid $300,000 cash for all assets and liabilities of Sampras, which will cease to exist as a separate entity. In connection with the acquisition, Pelham paid $10,000 in legal fees. Pelham also agreed to pay $50,000 to the former owners of Sampras contingent on meeting certain revenue goals during 2012. Pelham estimated the present value of its probability adjusted expected payment for the contingency at $15,000. In determining its offer, Pelham noted the following pertaining to Sampras:
• It holds a building with a fair value $40,000 more than its book value.
• It has developed a customer list appraised at $22,000, although it is not recorded in its financial records.
• It has research and development activity in process with an appraised fair value of $30,000.
However, the project has not yet reached technological feasibility and the assets used in the activity have no alternative future use.
• Book values for the receivables, inventory, equipment, and liabilities approximate fair values. Prepare Pelham’s accounting entry to record the combination with Sampras using the
SafeData Corporation has the following account balances and respective fair values on June 30:
Book Values
Fair Values
Receivables
$80,000
$80,000
Patented technology
100,000
700,000
Customer relationships
–0–
500,000
In process research and development
–0–
300,000
Liabilities
400,000
400,000
Common stock
100,000
Additional paid in capital
300,000
Retained earnings deficit, 1/1
700,000
Revenues
300,000
Expenses
220,000
Privacy First, Inc., obtained all of the outstanding shares of SafeData on June 30 by issuing 20,000 shares of common stock having a $1 par value but a $75 fair market value. Privacy First incurred $10,000 in stock issuance costs and paid $75,000 to an investment banking firm for its assistance in arranging the combination. In negotiating the final terms of the deal, Privacy First also agrees to pay $100,000 to SafeData’s former owners if it achieves certain revenue goals in the next two years. Privacy First estimates the probability adjusted present value of this contingent performance obligation at $30,000. The transaction is to be accounted for using the acquisition method.
a. What is the fair value of the consideration transferred in this combination?
b. How should the stock issuance costs appear in Privacy First’s post combination financial statements?
c. How should Privacy First account for the fee paid to the investment bank?
d. How does the issuance of these shares affect the stockholders’ equity accounts of Privacy First, the parent?
e. How is the fair value of the consideration transferred in the combination allocated among the assets acquired and the liabilities assumed?
f. What is the effect of Safe Data’s revenues and expenses on consolidated totals? Why?
g. What is the effect of Safe Data’s Common Stock and Additional Paid In Capital balances on consolidated totals?
h. If Privacy First’s stock had been worth only $50 per share rather than $75, how would the consolidation of SafeData’s assets and liabilities have been affected?
On January 1, 2011, NewTune Company exchanges 15,000 shares of its common stock for all of the outstanding shares of On the Go, Inc. Each of NewTune’s shares has a $4 par value and a $50 fair value. The fair value of the stock exchanged in the acquisition was considered equal to On the Go’s fair value. NewTune also paid $25,000 in stock registration and issuance costs in connection with the merger. Several of On the Go’s accounts have fair values that differ from their book values on this date:
Book Values
Fair Values
Receivables
$65,000
$63,000
Trademarks
95,000
225,000
Record music catalog
60,000
180,000
In process research and development
–0–
200,000
Notes payable
50,000
45,000
Precombination January 1, 2011, book values for the two companies are as follows:
NewTune
On the Go
Cash
$60,000
$29,000
Receivables
150,000
65,000
Trademarks
400,000
95,000
Record music catalog
840,000
60,000
Equipment (net)
320,000
105,000
Totals
$1,770,000
$354,000
Accounts payable
($110,000)
($34,000)
Notes payable
370,000
50,000
Common stock
400,000
50,000
Additional paid in capital
30,000
30,000
Retained earnings
860,000
190,000
Totals
($1,770,000)
($354,000)
Required:
a. Assume that this combination is a statutory merger so that On the Go’s accounts will be transferred to the records of NewTune. On the Go will be dissolved and will no longer exist as a legal entity. Using the acquisition method, prepare a postcombination balance sheet for NewTune as of the acquisition date.
b. Assume that no dissolution takes place in connection with this combination. Rather, both companies retain their separate legal identities. Using the acquisition method, prepare a worksheet to consolidate the two companies as of the combination date.
c. How do the balance sheet accounts compare across parts (a) and (b)?
Bakel Corporation has the following December 31 account balances:
Receivables
$ 80,000
Inventory
200,000
Land
600,000
Building
500,000
Liabilities
(400,000)
Common stock
(100,000)
Additional paid in capital
(100,000)
Retained earnings, 1/1
(700,000)
Revenues
(300,000)
Expenses
220,000
Several of Bakel’s accounts have fair values that differ from book value: land—$400,000; building— $600,000; inventory—$280,000; and liabilities—$330,000. Homewood, Inc., obtains all of Bakel’s outstanding shares by issuing 20,000 shares of common stock having a $5 par value but a $55 fair value. Stock issuance costs amount to $10,000.
a. What is the purchase price in this combination?
b. What is the book value of Bakel’s net assets on the date of the takeover?
c. How are the stock issuance costs handled?
d. How does the issuance of these shares affect the stockholders’ equity accounts of Homewood, the parent?
e. What allocations are made of Homewood’s purchase price to specific accounts and to goodwill?
f. If Bakel had in process research and development assets (with no alternative future uses) valued at $60,000, how would the allocations in part (e) change? Where is acquired in process research and development typically reported on consolidated financial statements?
g. How do Bakel’s revenues and expenses affect consolidated totals? Why?
h. How do Bakel’s common stock and additional paid in capital balances affect consolidated totals?
i. In financial statements prepared immediately following the takeover, what impact will this acquisition have on the various consolidated totals?
j. If Homewood’s stock had been worth only $40 per share rather than $55, how would the consolidation of Bakel’s assets and liabilities have been affected?
Winston has the following account balances as of February 1.
Inventory
$ 600,000
Land
500,000
Buildings (net) (valued at $1,000,000)
900,000
Common stock ($10 par value)
(800,000)
Retained earnings, 1/1
(1,100,000)
Revenues
(600,000)
Expenses
500,000
Arlington pays $1.4 million cash and issues 10,000 shares of its $30 par value common stock (valued at $80 per share) for all of Winston’s outstanding stock. Stock issuance costs amount to $30,000. Prior to recording these newly issued shares, Arlington reports a Common Stock account of $900,000 and Additional Paid In Capital of $500,000. For each of the following accounts, determine what balance would be included in a February 1 consolidation.
Flaherty Company entered into a business combination with Steeley Company in March 2001. The combination was accounted for as a pooling of interests. Registration fees were incurred in issuing common stock in this combination. Other costs, such as legal and accounting fees, were also paid.
a. In the business combination accounted for as a pooling of interests, how should the assets and liabilities of the two companies be included within consolidated statements? What was the rationale for accounting for a business combination as a pooling of interests?
b. In the business combination accounted for as a pooling of interests, how were the registration fees and the other direct costs recorded?
c. In the business combination accounted for as a pooling of interests, how were the results of the operations for 2001 reported?
On February 1, Piscina Corporation completed a combination with Swimwear Company accounted for as a pooling of interests. At that date, Swimwear’s account balances were as follows:
Book Values
Fair Values
Inventory
$600,000
$650,000
Land
450,000
750,000
Buildings
900,000
1,000,000
Unpatented technology
–0–
1,500,000
Common stock ($10 par value)
750,000
Retained earnings, 1/1
1,100,000
Revenues
600,000
Expenses
500,000
Piscina issued 30,000 shares of its common stock with a par value of $25 and a fair value of $150 per share to the owners of Swimwear for all of their Swimwear shares. Upon completion of the combination, Swimwear Company was formally dissolved.
Prior to 2002, business combinations were accounted for using either purchase or pooling of interests accounting. The two methods often produced substantially different financial statement effects. For the scenario above,
a. What are the respective consolidated values for Swimwear’s assets under the pooling method and the purchase method?
b. Under each of the following methods, how would Piscina account for Swimwear’s current year, but prior to acquisition, revenues and expenses?
• Pooling of interests method
• Purchase method
c. Explain the alternative impact of pooling versus purchase accounting on performance ratios such as return on assets and earnings per share in periods subsequent to the combination.
Navi Now Company agrees to pay $20 million in cash to the four former owners of Traffic Eye for all of its assets and liabilities. These four owners of Traffic Eye developed and patented a technology for real time monitoring of traffic patterns on the nation’s top 200 frequently congested highways. Navi Now plans to combine the new technology with its existing global positioning systems and projects a resulting substantial revenue increase.
As part of the acquisition contract, Navi Now also agrees to pay additional amounts to the former owners upon achievement of certain financial goals. Navi Now will pay $8 million to the four former owners of Traffic Eye if revenues from the combined system exceed $100 million over the next three years. Navi
Now estimates this contingent payment to have a probability adjusted present value of $4 million.
The four former owners have also been offered employment contracts with Navi Now to help with system integration and performance enhancement issues. The employment contracts are silent as to service periods, have nominal salaries similar to those of equivalent employees, and specify a profit sharing component over the next three years (if the employees remain with the company) that Navi Now estimates to have a current fair value of $2 million. The four former owners of Traffic Eye say they will stay on as employees of Navi Now for at least three years to help achieve the desired financial goals.
Should NaviNow account for the contingent payments promised to the former owners of Traffic Eye as consideration transferred in the acquisition or as compensation expense to employees?
Top Company acquired all of Bottom Company’s outstanding common stock for $842,000 in cash. As of that date, one of Bottom’s buildings with a 12 year remaining life was undervalued on its financial records by $72,000. Equipment with a 10 year life was undervalued, but only by $10,000. The book values of all of Bottom’s other assets and liabilities were equal to their fair values at that time except for an unrecorded licensing agreement with an assessed value of $40,000 and a 20 year remaining useful life. Bottom’s book value at the acquisition date was $720,000.
During 2011, Bottom reported net income of $100,000 and paid $30,000 in dividends. Earnings were $120,000 in 2012 with $20,000 in dividends distributed by the subsidiary. As of December 31, 2013, the companies reported the following selected balances, which include all revenues and expenses for the year:
Top Company December 31, 2013
Bottom Company December 31, 2013
Debit
Credit
Debit
Credit
Buildings
$1,540,000
$460,000
Cash and receivables
50,000
90,000
Common stock
$900,000
$400,000
Dividends paid
70,000
10,000
Equipment
280,000
200,000
Cost of goods sold
500,000
120,000
Depreciation expense
100,000
60,000
Inventory
280,000
260,000
Land
330,000
250,000
Liabilities
480,000
260,000
Retained earnings, 1/1/13
1,360,000
490,000
Revenues
900,000
300,000
Required
a. If Top applies the equity method, what is its investment account balance as of December 31, 2013?
b. If Top applies the initial value method, what is its investment account balance as of December 31, 2013?
c. Regardless of the accounting method in use by Top, what are the consolidated totals as of December 31, 2013, for each of the following accounts?
Buildings
Revenues
Equipment
Net Income
Land
Investment in Bottom
Depreciation Expense
Dividends Paid
Amortization Expense
Cost of Goods Sold
d. Prepare the worksheet entries required on December 31, 2013, to consolidate the financial records of these two companies. Assume that Top applied the equity method to its investment account.
e. How would the worksheet entries in requirement (d) be altered if Top has used the initial value method?
On January 1, 2010, Big Company pays $70,000 for a 10 percent interest in Little Company. On that date, Little has a book value of $600,000, although equipment, which has a five year life, is undervalued by $100,000 on its books. Little Company’s stock is closely held by a few investors and is traded only infrequently.
Because fair values are not readily available on a continuing basis, the investment account is appropriately maintained at cost.
On January 1, 2011, Big acquires an additional 30 percent of Little Company for $264,000. This second purchase provides Big the ability to exert significant influence over Little and Big will now apply the equity method. At the time of this transaction, Little’s equipment with a four year life was undervalued by only $80,000. During these two years, Little reported the following operational results:
Year
Net Income
Cash Dividends Paid
2010
$210,000
$110,000
2011
250,000
100,000
Additional Information
• Cash dividends are always paid on July 1 of each year.
• Any goodwill is considered to have an indefinite life.
Required
a. What income did Big originally report for 2010 in connection with this investment?
b. On comparative financial statements for 2010 and 2011, what figures should Big report in connection with this investment?
Alex, Inc., buys 40 percent of Steinbart Company on January 1, 2010, for $530,000. The equity method of accounting is to be used. Steinbart’s net assets on that date were $1.2 million. Any excess of cost over book value is attributable to a trade name with a 20 year remaining life. Steinbart immediately begins supplying inventory to Alex as follows:
Year
Cost to Steinbart
Transfer Price
Amount Held by Alex at Year End (at Transfer Price)
2010
$70,000
$100,000
$25,000
2011
96,000
150,000
45,000
Inventory held at the end of one year by Alex is sold at the beginning of the next. Steinbart reports net income of $80,000 in 2010 and $110,000 in 2011 while paying $30,000 in dividends each year. What is the equity income in Steinbart to be reported by Alex in 2011?
On January 1, 2010, Alison, Inc., paid $60,000 for a 40 percent interest in Holister Corporation’s common stock. This investee had assets with a book value of $200,000 and liabilities of $75,000. A patent held by Holister having a $5,000 book value was actually worth $20,000. This patent had a six year remaining life. Any further excess cost associated with this acquisition was attributed to goodwill. During 2010, Holister earned income of $30,000 and paid dividends of $10,000. In 2011, it had income of $50,000 and dividends of $15,000. During 2011, the fair value of Allison’s investment in Holister had risen from $68,000 to $75,000.
a. Assuming Alison uses the equity method, what balance should appear in the Investment in Holister account as of December 31, 2011?
b. Assuming Alison uses the fair value option, what income from the investment in Holister should be reported for 2011?
Waters, Inc., acquired 10 percent of Denton Corporation on January 1, 2010, for $210,000 although Denton”s book value on that date was $1,700,000. Denton held land that was undervalued by $100,000 on its accounting records. During 2010, Denton earned a net income of $240,000 while paying cash dividends of $90,000. On January 1, 2011, Waters purchased an additional 30 percent of Denton for $600,000. Denton”s land is still undervalued on that date, but then by $120,000. Any additional excess cost was attributable to a trademark with a 10 year life for the first purchase and a 9 year life for the second. The initial 10 percent investment had been maintained at cost because fair values were not readily available. The equity method will now be applied. During 2011, Denton reported income of $300,000 and distributed dividends of $110,000. Prepare all of the 2011 journal entries for Waters.
On January 1, 2009, Monroe, Inc., purchased 10,000 shares of Brown Company for $250,000, giving Monroe 10 percent ownership of Brown. On January 1, 2010, Monroe purchased an additional 20,000 shares (20 percent) for $590,000. This latest purchase gave Monroe the ability to apply significant influence over Brown. The original 10 percent investment was categorized as an available for sale security. Any excess of cost over book value acquired for either investment was attributed solely to goodwill.
Brown reports net income and dividends as follows. These amounts are assumed to have occurred evenly throughout these years.
Net Income
Cash Dividends (paid quarterly)
2009
$350,000
$100,000
2010
480,000
110,000
2011
500,000
120,000
On July 1, 2011, Monroe sells 2,000 shares of this investment for $46 per share, thus reducing its interest from 30 to 28 percent. However, the company retains the ability to significantly influence Brown. Using the equity method, what amounts appear in Monroe’s 2011 income statement?
Collins, Inc., purchased 10 percent of Merton Corporation on January 1, 2010, for $345,000 and classified the investment as an available for sale security. Collins acquires an additional 15 percent of Merton on January 1, 2011, for $580,000. The equity method of accounting is now appropriate for this investment. No intra entity sales have occurred.
a. How does Collins initially determine the income to be reported in 2010 in connection with its ownership of Merton?
b. What factors should have influenced Collins in its decision to apply the equity method in 2011?
c. What factors could have prevented Collins from adopting the equity method after this second purchase?
d. What is the objective of the equity method of accounting?
e. What criticisms have been leveled at the equity method?
f. In comparative statements for 2010 and 2011, how would Collins determine the income to be reported in 2010 in connection with its ownership of Merton? Why is this accounting appropriate?
g. How is the allocation of Collins’s acquisition made?
h. If Merton pays a cash dividend, what impact does it have on Collins’s financial records under the equity method? Why is this accounting appropriate?
i. On financial statements for 2011, what amounts are included in Collins’s Investment in Merton account? What amounts are included in Collins’s Equity in Income of Merton account?
Parrot Corporation holds a 42 percent ownership of Sunrise, Inc. The equity method is being applied. Parrot assigned the entire original excess purchase price over book value to goodwill. During 2010, the two companies made intra entity inventory transfers. A portion of this merchandise was not resold until 2011. During 2011, additional transfers were made.
a. What is the difference between upstream transfers and downstream transfers?
b. How does the direction of an intra entity transfer (upstream versus downstream) affect the application of the equity method?
c. How is the intra entity unrealized gross profit computed in applying the equity method?
d. How should Parrot compute the amount of equity income to be recognized in 2010? What entry is made to record this income?
e. How should Parrot compute the amount of equity income to be recognized in 2011?
f. If none of the transferred inventory had remained at the end of 2010, how would these transfers have affected the application of the equity method?
g. How do these intra entity transfers affect Sunrise’s financial reporting?
Several years ago, Einstein, Inc., bought 40 percent of the outstanding voting stock of Brooks Company. The equity method is appropriately applied. On August 1 of the current year, Einstein sold a portion of these shares.
a. How does Einstein compute the book value of this investment on August 1 to determine its gain or loss on the sale?
b. How should Einstein account for this investment after August 1?
c. If Einstein retains only a 2 percent interest in Brooks so that it holds virtually no influence over Brooks, what figures appear in the investor’s income statement for the current year?
d. If Einstein retains only a 2 percent interest in Brooks so that virtually no influence is held, does the investor have to retroactively adjust any previously reported figures?
Russell owns 30 percent of the outstanding stock of Thacker and has the ability to significantly influence the investee’s operations and decision making. On January 1, 2011, the balance in the Investment in Thacker account is $335,000. Amortization associated with this acquisition is $9,000 per year. In 2011, Thacker earns an income of $90,000 and pays cash dividends of $30,000. Previously, in 2010, Thacker had sold inventory costing $24,000 to Russell for $40,000. Russell consumed all but 25 percent of this merchandise during 2010 and used the rest during 2011. Thacker sold additional inventory costing $28,000 to Russell for $50,000 in 2011. Russell did not consume 40 percent of these 2011 purchases from Thacker until 2012.
a. What amount of equity method income would Russell recognize in 2011 from its ownership interest in Thacker?
b. What is the equity method balance in the Investment in Thacker account at the end of 2011?
On January 1, 2010, Allan acquires 15 percent of Bellevue’s outstanding common stock for $62,000. Allan classifies the investment as an available for sale security and records any unrealized holding gains or losses directly in owners’ equity. On January 1, 2011, Allan buys an additional 10 percent of Bellevue for $43,800, providing Allan the ability to significantly influence Bellevue’s decisions. During the next two years, the following information is available for Bellevue:
Income
Dividends
Common Stock Fair Value (12/31)
2010
$80,000
$30,000
$438,000
2011
100,000
40,000
468,000
In each purchase, Allan attributes any excess of cost over book value to Bellevue’s franchise agreements that had a remaining life of 10 years at January 1, 2010. Also at January 1, Bellevue reports a net book value of $280,000.
a. Assume Allan applies the equity method to its Investment in Bellevue account:
1. On Allan’s December 31, 2011, balance sheet, what amount is reported for the Investment in Bellevue account?
2. What amount of equity income should Allan report for 2011?
3. Prepare the January 1, 2011, journal entry to retrospectively adjust the Investment in Bellevue account to the equity method.
b. Assume Allan elects the fair value reporting option for its investment in Bellevue:
1. On Allan’s December 31, 2011, balance sheet, what amount is reported for the Investment in Bellevue account?
2. What amount of income from its investment in Bellevue should Allan report for 2011?
Anderson acquires 10 percent of the outstanding voting shares of Barringer on January 1, 2009, for $92,000 and categorizes the investment as an available for sale security. An additional 20 percent of the stock is purchased on January 1, 2010, for $210,000, which gives Anderson the ability to significantly influence Barringer. Barringer has a book value of $800,000 at January 1, 2009, and records net income of $180,000 for that year. Barringer paid dividends of $80,000 during 2009. The book values of Barringer’s asset and liability accounts are considered as equal to fair values except for a copyright whose value accounted for Anderson’s excess cost in each purchase. The copyright had a remaining life of 16 years at January 1, 2009.
Barringer reported $210,000 of net income during 2010 and $230,000 in 2011. Dividends of $100,000 are paid in each of these years. Anderson uses the equity method.
a. On comparative income statements issued in 2011 by Anderson for 2009 and 2010, what amounts of income would be reported in connection with the company’s investment in Barringer?
b. If Anderson sells its entire investment in Barringer on January 1, 2012, for $400,000 cash, what is the impact on Anderson’s income?
c. Assume that Anderson sells inventory to Barringer during 2010 and 2011 as follows:
Year
Cost to Anderson
Price to Barringer
Year End Balance (at Transfer Price)
2010
$35,000
$50,000
$20,000 (sold in following year)
2011
33,000
60,000
40,000 (sold in following year)
What amount of equity income should Anderson recognize for the year 2011?
Smith purchased 5 percent of Barker’s outstanding stock on October 1, 2009, for $7,475 and acquired an additional 10 percent of Barker for $14,900 on July 1, 2010. Both of these purchases were accounted for as available for sale investments. Smith purchases a final 20 percent on December 31, 2011, for $34,200. With this final acquisition, Smith achieves the ability to significantly influence Barker’s decision making process and employs the equity method.
Barker has a book value of $100,000 as of January 1, 2009. Information follows concerning the operations of this company for the 2009–2011 period. Assume that all income was earned uniformly in each year. Assume also that one fourth of the total annual dividends are paid at the end of each calendar quarter.
Year
Reported Income
Dividends
2009
$20,000
$8,000
2010
30,000
16,000
2011
24,000
9,000
On Barker’s financial records, the book values of all assets and liabilities are the same as their fair values. Any excess cost from either purchase relates to identifiable intangible assets. For each purchase, the excess cost is amortized over 15 years. Amortization for a portion of a year should be based on months.
a. On comparative income statements issued in 2012 for the years of 2009, 2010, and 2011, what would Smith report as its income derived from this investment in Barker?
b. On a balance sheet as of December 31, 2011, what should Smith report as investment in Barker?
Hobson acquires 40 percent of the outstanding voting stock of Stokes Company on January 1, 2010, for $210,000 in cash. The book value of Stokes’s net assets on that date was $400,000, although one of the company’s buildings, with a $60,000 carrying value, was actually worth $100,000. This building had a 10 year remaining life. Stokes owned a royalty agreement with a 20 year remaining life that was undervalued by $85,000. Stokes sold inventory with an original cost of $60,000 to Hobson during 2010 at a price of $90,000. Hobson still held $15,000 (transfer price) of this amount in inventory as of December 31, 2010. These goods are to be sold to outside parties during 2011.
Stokes reported a loss of $60,000 for 2010, $40,000 from continuing operations and $20,000 from an extraordinary loss. The company still manages to pay a $10,000 cash dividend during the year.
During 2011, Stokes reported a $40,000 net income and distributed a cash dividend of $12,000. It made additional inventory sales of $80,000 to Hobson during the period. The original cost of the merchandise was $50,000. All but 30 percent of this inventory had been resold to outside parties by the end of the 2011 fiscal year. Prepare all journal entries for Hobson for 2010 and 2011 in connection with this investment. Assume that the equity method is applied.
Penston Company owns 40 percent (40,000 shares) of Scranton, Inc., which it purchased several years ago for $182,000. Since the date of acquisition, the equity method has been properly applied, and the book value of the investment account as of January 1, 2011, is $248,000. Excess patent cost amortization of $12,000 is still being recognized each year. During 2011, Scranton reports net income of $200,000, $320,000 in operating income earned evenly throughout the year, and a $120,000 extraordinary loss incurred on October 1. No dividends were paid during the year. Penston sold 8,000 shares of Scranton on August 1, 2011, for $94,000 in cash. However, Penston retains the ability to significantly influence the investee. During the last quarter of 2010, Penston sold $50,000 in inventory (which it had originally purchased for only $30,000) to Scranton. At the end of that fiscal year, Scranton”s inventory retained $9,000 (at sales price) of this merchandise, which was subsequently sold in the first quarter of 2011. On Penston”s financial statements for the year ended December 31, 2011, what income effects would be reported from its ownership in Scranton?
On July 1, 2009, Gibson Company acquired 75,000 of the outstanding shares of Miller Company for $12 per share. This acquisition gave Gibson a 35 percent ownership of Miller and allowed Gibson to significantly influence the investee’s decisions.
As of July 1, 2009, the investee had assets with a book value of $2 million and liabilities of $400,000. At the time, Miller held equipment appraised at $150,000 above book value; it was considered to have a seven year remaining life with no salvage value. Miller also held a copyright with a five year remaining life on its books that was undervalued by $650,000. Any remaining excess cost was attributable to goodwill. Depreciation and amortization are computed using the straight line method. Gibson applies the equity method for its investment in Miller. Miller’s policy is to pay a $1 per share cash dividend every April 1 and October 1. Miller’s income, earned evenly throughout each year, was $550,000 in 2009, $575,000 in 2010, and $620,000 in 2011.
In addition, Gibson sold inventory costing $90,000 to Miller for $150,000 during 2010. Miller resold $80,000 of this inventory during 2010 and the remaining $70,000 during 2011.
a. Prepare a schedule computing the equity income to be recognized by Gibson during each of these years.
b. Compute Gibson’s investment in Miller Company’s balance as of December 31, 2011.
On January 1, 2009, Plano Company acquired 8 percent (16,000 shares) of the outstanding voting shares of the Sumter Company for $192,000, an amount equal to Sumter’s underlying book and fair value. Sumter pays a cash dividend to its stockholders each year of $100,000 on September 15. Sumter reported net income of $300,000 in 2009, $360,000 in 2010, $400,000 in 2011, and $380,000 in 2012. Each income figure can be assumed to have been earned evenly throughout its respective year. In addition, the fair value of these 16,000 shares was indeterminate, and therefore the investment account remained at cost.
On January 1, 2011, Plano purchased an additional 32 percent (64,000 shares) of Sumter for $965,750 in cash and began to use the equity method. This price represented a $50,550 payment in excess of the book value of Sumter’s underlying net assets. Plano was willing to make this extra payment because of a recently developed patent held by Sumter with a 15 year remaining life. All other assets were considered appropriately valued on Sumter’s books. On July 1, 2012, Plano sold 10 percent (20,000 shares) of Sumter’s outstanding shares for $425,000 in cash. Although it sold this interest, Plano maintained the ability to significantly influence Sumter’s decision making process. Assume that Plano uses a weighted average costing system. Prepare the journal entries for Plano for the years of 2009 through 2012.
On January 1, 2010, Stream Company acquired 30 percent of the outstanding voting shares of Q Video, Inc., for $770,000. Q Video manufactures specialty cables for computer monitors. On that date, Q Video reported assets and liabilities with book values of $1.9 million and $700,000, respectively. A customer list compiled by Q Video had an appraised value of $300,000, although it was not recorded on its books. The expected remaining life of the customer list was five years with a straight line depreciation deemed appropriate. Any remaining excess cost was not identifiable with any particular asset and thus was considered goodwill.
Q Video generated net income of $250,000 in 2010 and a net loss of $100,000 in 2011. In each of these two years, Q Video paid a cash dividend of $15,000 to its stockholders. During 2010, Q Video sold inventory that had an original cost of $100,000 to Stream for $160,000. Of this balance, $80,000 was resold to outsiders during 2010, and the remainder was sold during 2011. In 2011, Q Video sold inventory to Stream for $175,000. This inventory had cost only $140,000. Stream resold $100,000 of the inventory during 2011 and the rest during 2012. For 2010 and then for 2011, compute the amount that Stream should report as income from its investment in Q Video in its external financial statements under the equity method.
On January 1, 2011, Acme Co. is considering purchasing a 40 percent ownership interest in PHC Co., a privately held enterprise, for $700,000. PHC predicts its profit will be $185,000 in 2011, projects a 10 percent annual increase in profits in each of the next four years, and expects to pay a steady annual dividend of $30,000 for the foreseeable future. Because PHC has on its books a patent that is undervalued by $375,000, Acme realizes that it will have an additional amortization expense of $15,000 per year over the next 10 years—the patent’s estimated useful life. All of PHC’s other assets and liabilities have book values that approximate market values. Acme uses the equity method for its investment in PHC.
Required
1. Using an Excel spreadsheet, set the following values in cells:
• Acme’s cost of investment in PHC.
• Percentage acquired.
• First year PHC reported income.
• Projected growth rate in income.
• PHC annual dividends.
• Annual excess patent amortization.
2. Referring to the values in (1), prepare the following schedules using columns for the years 2011 through 2015.
• Acme’s equity in PHC earnings with rows showing these:
• Acme’s share of PHC reported income.
• Amortization expense.
• Acme’s equity in PHC earnings.
• Acme’s Investment in PHC balance with rows showing the following:
• Beginning balance.
• Equity earnings.
• Dividends.
• Ending balance.
• Return on beginning investment balance _ Equity earnings/Beginning investment balance in each year.
3. Given the preceding values, compute the average of the projected returns on beginning investment balances for the first five years of Acme’s investment in PHC. What is the maximum Acme can pay for PHC if it wishes to earn at least a 10 percent average return on beginning investment balance? (Hint: Under Excel’s Tools menu, use the Solver or Goal Seek capability to produce a 10 percent average return on beginning investment balance by changing the cell that contains Acme’s cost of investment in PHC. Excel’s Solver should produce an exact answer while Goal Seek should produce a close approximation. You may need to first add in the Solver capability under Excel’s Tools menu.)
On January 1, Intergen, Inc., invests $200,000 for a 40 percent interest in Ryan, a new joint venture with two other partners each investing $150,000 for 30 percent interests. Intergen plans to sell all of its production to Ryan, which will resell the inventory to retail outlets. The equity partners agree that Ryan will buy inventory only from Intergen. Also, Intergen plans to use the equity method for financial reporting. During the year, Intergen expects to incur costs of $850,000 to produce goods with a final retail market value of $1,200,000. Ryan projects that, during this year, it will resell three fourths of these goods for $900,000. It should sell the remainder in the following year. The equity partners plan a meeting to set the price Intergen will charge Ryan for its production. One partner suggests a transfer price of $1,025,000 but is unsure whether it will result in an equitable return across the equity holders. Importantly, Intergen agrees that its total rate of return (including its own operations and its investment in Ryan) should be equal to that of the other investors’ return on their investments in Ryan. All agree that Intergen’s value including its investment in Ryan is $1,000,000.
Required
1. Create an Excel spreadsheet analysis showing the following:
• Projected income statements for Intergen and Ryan. Formulate the statements to do the following:
• Link Ryan’s cost of goods sold to Intergen’s sales (use a starting value of $1,025,000 for Intergen’s sales).
• Link Intergen’s equity in Ryan’s earnings to Ryan’s net income (adjusted for Intergen’s gross profit rate XRyan’s ending inventory X 40 percent ownership percentage).
• Be able to change Intergen’s sales and see the effects throughout the income statements of Ryan and Intergen. Note that the cost of goods sold for Intergen is fixed.
• The rate of return for the two 30 percent equity partners on their investment in Ryan.
• The total rate of return for Intergen based on its $1,000,000 value.
2. What transfer price will provide an equal rate of return for each of the investors in the first year of operation? (Hint: Under Excel’s Tools menu, use the Goal Seek or Solver capability to produce a zero difference in rates of return across the equity partners by changing the cell that contains Intergen’s sales.)
Required
Address the following:
1. How does The Coca Cola Company account for its investment in Coca Cola Enterprises, Inc. (CCE)? What are the accounting implications of the method Coca Cola uses?
2. What criterion does Coca Cola use to choose the method of accounting for its investment in CCE?
3. Describe the relationship between Coca Cola and CCE.
4. Calculate the debt to equity ratios in the most recent two years for both Coca Cola and CCE. Does Coca Cola have the ability to influence CCE’s debt levels?
5. How are Coca Cola’s financials affected by its relationship with CCE? In general, how would Coca Cola’s financials change if it consolidated CCE?
Wolf Pack Transport Co. has a 25 percent equity investment in Maggie Valley Depot (MVD), Inc., which owns and operates a warehousing facility used for the collection and redistribution of various consumer goods. Wolf Pack paid $1,685,000 for MVD several years ago, including a $300,000 allocation for goodwill as the only excess cost over book value acquired. Wolf Pack Transport has since appropriately applied the equity method to account for the investment in its internal and external financial reports. In its most recent balance sheet, because of recognized profits in excess of dividends since the acquisition, Wolf Pack reported a $2,350,000 amount for its Investment in Maggie Valley Depot, Inc., account. However, competition in the transit warehousing industry has increased in the past 12 months. In the same area as the MVD facility, a competitor company opened two additional warehouses that are much more conveniently located near a major interstate highway. MVD’s revenues declined 30 percent as customers shifted their business to the competitor’s facilities and the prices for warehouse services declined. The market value of Wolf Pack’s stock ownership in MVD fell to $1,700,000 from a high last year of $2,500,000. MVD’s management is currently debating ways to respond to these events but has yet to formulate a firm plan.
Required
1. What guidance does the FASB ASC provide for equity method investment losses in value?
2. Should Wolf Pack recognize the decline in the value of its holdings in MVD in its current year financial statements?
3. Should Wolf Pack test for impairment of the value it had initially assigned to goodwill?
(Fair Value) Addison Manufacturing holds a large portfolio of debt and equity securities as an investment. The fair value of the portfolio is greater than its original cost, even though some securities have decreased in value. Sam Beresford, the financial vice president, and Angie Nielson, the controller, are near year end in the process of classifying for the first time this securities portfolio in accordance with GAAP. Beresford wants to classify those securities that have increased in value during the period as trading securities in order to increase net income this year. He wants to classify all the securities that have decreased in value as available for sale (the equity securities) and as held to maturity (the debt securities). Nielson disagrees. She wants to classify those securities that have decreased in value as trading securities and those that have increased in value as available for sale (equity) and held to maturity (debt). She contends that the company is having a good earnings year and that recognizing the losses will help to smooth the income this year. As a result, the company will have built in gains for future periods when the company may not be as profitable.
Instructions
Answer the following questions.
(a) Will classifying the portfolio as each proposes actually have the effect on earnings that each says it will?
(b) Is there anything unethical in what each of them proposes? Who are the stakeholders affected by their proposals?
(c) Assume that Beresford and Nielson properly classify the entire portfolio into trading, available for sale, and held to maturity categories. But then each proposes to sell just before year end the securities with gains or with losses, as the case may be, to accomplish their effect on earnings. Is this unethical?
At December 31, 2012, Grinkov Corporation had the following account balances.
Installment Accounts Receivable, 2011
$ 65,000
Installment Accounts Receivable, 2012
110,000
Deferred Gross Profi t, 2011
23,400
Deferred Gross Profi t, 2012
41,800
Most of Grinkov’s sales are made on a 2 year installment basis. Indicate how these accounts would be reported in Grinkov’s December 31, 2012, balance sheet. The 2011 accounts are collectible in 2013, and the 2012 accounts are collectible in 2014.
(Revenue Recognition—Point of Sale) Wood Mode Company is involved in the design, manufacture, and installation of various types of wood products for large construction projects. Wood Mode recently completed a large contract for Stadium Inc., which consisted of building 35 different types of concession counters for a new soccer arena under construction. The terms of the contract are that upon completion of the counters, Stadium would pay $2,000,000. Unfortunately, due to the depressed economy, the completion of the new soccer arena is now delayed. Stadium has therefore asked Wood Mode to hold the counters at its manufacturing plant until the arena is completed. Stadium acknowledges in writing that it ordered the counters and that they now have ownership. The time that Wood Mode Company must hold the counters is totally dependent on when the arena is completed. Because Wood Mode has not received additional progress payments for the arena due to the delay, Stadium has provided a deposit of $300,000.
Instructions
(a) Explain this type of revenue recognition transaction.
(b) What factors should be considered in determining when to recognize revenue in this transaction?
(c) Prepare the journal entry(ies) that Wood Mode should make, assuming it signed a valid sales contract to sell the counters and received at the time of sale the $300,000 payment.
(Revenue Recognition on Book Sales with High Returns) Uddin Publishing Co. publishes college textbooks that are sold to bookstores on the following terms. Each title has a fixed wholesale price, terms f.o.b. shipping point, and payment is due 60 days after shipment. The retailer may return a maximum of 30% of an order at the retailer’s expense. Sales are made only to retailers who have good credit ratings. Past experience indicates that the normal return rate is 12%, and the average collection period is 72 days.
Instructions
(a) Identify alternative revenue recognition criteria that Uddin could employ concerning textbook sales.
(b) Briefly discuss the reasoning for your answers in (a) above.
(c) In late July, Uddin shipped books invoiced at $15,000,000. Prepare the journal entry to record this event that best conforms to GAAP and your answer to part (b).
(d) In October, $2 million of the invoiced July sales were returned according to the return policy, and the remaining $13 million was paid. Prepare the entries for the return and payment.
(Sales Recorded Both Gross and Net) On June 3, Hunt Company sold to Ann Mount merchandise having a sales price of $8,000 with terms of 2/10, n/60, f.o.b. shipping point. An invoice totaling $120, terms n/30, was received by Mount on June 8 from the Olympic Transport Service for the freight cost. Upon receipt of the goods, June 5, Mount notified Hunt Company that merchandise costing $600 contained flaws that rendered it worthless. The same day, Hunt Company issued a credit memo covering the worthless merchandise and asked that it be returned at company expense. The freight on the returned merchandise was $24, paid by Hunt Company on June 7. On June 12, the company received a check for the balance due from Mount.
Instructions
(a) Prepare journal entries for Hunt Company to record all the events noted above under each of the following bases.
(1) Sales and receivables are entered at gross selling price.
(2) Sales and receivables are entered net of cash discounts.
(b) Prepare the journal entry under basis (2), assuming that Ann Mount did not remit payment until August 5.
(Revenue Recognition on Marina Sales with Discounts) Taylor Marina has 300 available slips that rent for $800 per season. Payments must be made in full at the start of the boating season, April 1, 2013. Slips for the next season may be reserved if paid for by December 31, 2012. Under a new policy, if payment is made by December 31, 2012, a 5% discount is allowed. The boating season ends October 31, and the marina has a December 31 year end. To provide cash flow for major dock repairs, the marina operator is also offering a 20% discount to slip renters who pay for the 2014 season. For the fiscal year ended December 31, 2012, all 300 slips were rented at full price. Two hundred slips were reserved and paid for the 2013 boating season, and 60 slips for the 2014 boating season were reserved and paid for.
Instructions
(a) Prepare the appropriate journal entries for fiscal 2012.
(b) Assume the marina operator is unsophisticated in business. Explain the managerial significance of the accounting above to this person.
(Multiple Deliverable Arrangement) Appliance Center is an experienced home appliance dealer. Appliance Center also offers a number of services together with the home appliances that it sells. Assume that Appliance Center sells ovens on a standalone basis. Appliance Center also sells installation services and maintenance services for ovens. However, Appliance Center does not offer installation or maintenance services to customers who buy ovens from other vendors. Pricing for ovens is as follows.
Oven only
$ 800
Oven with installation service
850
Oven with maintenance services
975
Oven with installation and maintenance services
1,000
In each instance in which maintenance services are provided, the maintenance service is separately priced within the arrangement at $175. Additionally, the incremental amount charged by Appliance Center for installation approximates the amount charged by independent third parties. Ovens are sold subject to a general right of return. If a customer purchases an oven with installation and/or maintenance services, in the event Appliance Center does not complete the service satisfactorily, the customer is only entitled to a refund of the portion of the fee that exceeds $800.
Instructions
(a) Assume that a customer purchases an oven with both installation and maintenance services for $1,000. Based on its experience, Appliance Center believes that it is probable that the installation of the equipment will be performed satisfactorily to the customer. Assume that the maintenance services are priced separately. Explain whether the conditions for a multiple deliverable arrangement exist in this situation.
(b) Indicate the amount of revenues that should be allocated to the oven, the installation, and to the maintenance contract.
(Recognition of Profit on Long Term Contracts) During 2012, Nilsen Company started a construction job with a contract price of $1,600,000. The job was completed in 2014. The following information is available.
2012
2013
2014
Costs incurred to date
$400,000
$825,000
$1,070,000
Estimated costs to complete
600,000
275,000
–0–
Billings to date
300,000
900,000
1,600,000
Collections to date
270,000
810,000
1,425,000
Instructions
(a) Compute the amount of gross profit to be recognized each year, assuming the percentage of completion method is used.
(b) Prepare all necessary journal entries for 2013.
(c) Compute the amount of gross profit to be recognized each year, assuming the completed contract method is used.
(Analysis of Percentage of Completion Financial Statements) In 2012, Steinrotter Construction Corp. began construction work under a 3 year contract. The contract price was $1,000,000. Steinrotter uses the percentage of completion method for financial accounting purposes. The income to be recognized each year is based on the proportion of cost incurred to total estimated costs for completing the contract. The financial statement presentations relating to this contract at December 31, 2012, are shown on the next page.
(Gross Profit on Uncompleted Contract) On April 1, 2012, Dougherty Inc. entered into a costplus fixed fee contract to construct an electric generator for Altom Corporation. At the contract date, Dougherty estimated that it would take 2 years to complete the project at a cost of $2,000,000. The fixed fee stipulated in the contract is $450,000. Dougherty appropriately accounts for this contract under the percentage of completion method. During 2012, Dougherty incurred costs of $800,000 related to the project. The estimated cost at December 31, 2012, to complete the contract is $1,200,000. Altom was billed $600,000 under the contract.
Instructions
Prepare a schedule to compute the amount of gross profit to be recognized by Dougherty under the contract for the year ended December 31, 2012.Show supporting computations in good form.
(Recognition of Profit, Percentage of Completion) In 2012, Gurney Construction Company agreed to construct an apartment building at a price of $1,200,000. The information relating to the costs and billings for this contract is shown below.
2012
2013
2014
Costs incurred to date
$280,000
$600,000
$ 785,000
Estimated costs yet to be incurred
520,000
200,000
–0–
Customer billings to date
150,000
500,000
1,200,000
Collection of billings to date
120,000
320,000
940,000
Instructions
(a) Assuming that the percentage of completion method is used, (1) compute the amount of gross profit to be recognized in 2012 and 2013, and (2) prepare journal entries for 2013.
(b) For 2013, show how the details related to this construction contract would be disclosed on the balance sheet and on the income statement.
(Recognition of Profit and Balance Sheet Amounts for Long Term Contracts) Yanmei Construction Company began operations January 1, 2012. During the year, Yanmei Construction entered into a contract with Lundquist Corp. to construct a manufacturing facility. At that time, Yanmei estimated that it would take 5 years to complete the facility at a total cost of $4,500,000. The total contract price for construction of the facility is $6,000,000. During the year, Yanmei incurred $1,185,800 in construction costs related to the construction project. The estimated cost to complete the contract is $4,204,200. Lundquist Corp. was billed and paid 25% of the contract price.
Instructions
Prepare schedules to compute the amount of gross profit to be recognized for the year ended December 31, 2012, and the amount to be shown as “costs and recognized profit on uncompleted contract in excess of related billings” or “billings on uncompleted contract in excess of related costs and recognized profit” at December 31, 2012, under each of the following methods.
(Long Term Contract Reporting) Berstler Construction Company began operations in 2012. Construction activity for the first year is shown below. All contracts are with different customers, and any work remaining at December 31, 2012, is expected to be completed in 2013.
Project
Total Contract Price
Billings through 12/31/12
Cash Collections through 12/31/12
Contract Costs Incurred through 12/31/12
Estimated Additional Costs to Complete
1
$ 560,000
$ 360,000
$340,000
$450,000
$130,000
2
670,000
220,000
210,000
126,000
504,000
3
520,000
500,000
440,000
330,000
–0–
$1,750,000
$1,080,000
$990,000
$906,000
$634,000
Instructions
Prepare a partial income statement and balance sheet to indicate how the above information would be reported for financial statement purposes. Berstler Construction Company uses the completed contract method.
(Installment Sales Method Calculations, Entries) Coffin Corporation appropriately uses the installment sales method of accounting to recognize income in its financial statements. The following information is available for 2012 and 2013.
2012
2013
Installment sales
$900,000
$1,000,000
Cost of installment sales
594,000
680,000
Cash collections on 2012 sales
370,000
350,000
Cash collections on 2013 sales
–0–
450,000
Instructions
(a) Compute the amount of realized gross profit recognized in each year.
(Analysis of Installment Sales Accounts) Samuels Co. appropriately uses the installment sales method of accounting. On December 31, 2014, the books show balances as follows.
Installment Receivables
Deferred Gross Profit
Gross Profit on Sales
2012
$12,000
2012
$ 7,000
2012
35%
2013
40,000
2013
26,000
2013
33%
2014
80,000
2014
95,000
2014
32%
Instructions
(a) Prepare the adjusting entry or entries required on December 31, 2014 to recognize 2014 realized gross profit. (Installment receivables have already been credited for cash receipts during 2014.)
(b) Compute the amount of cash collected in 2014 on accounts receivable from each year.
(Gross Profit Calculations and Repossessed Merchandise) Basler Corporation, which began business on January 1, 2012, appropriately uses the installment sales method of accounting. The following data were obtained for the years 2012 and 2013.
2012
2013
Installment sales
$750,000
$840,000
Cost of installment sales
510,000
588,000
General & administrative expenses
70,000
84,000
Cash collections on sales of 2012
310,000
300,000
Cash collections on sales of 2013
–0–
400,000
Instructions
(a) Compute the balance in the deferred gross profit accounts on December 31, 2012, and on December 31, 2013.
(b) A 2012 sale resulted in default in 2014. At the date of default, the balance on the installment receivable was $12,000, and the repossessed merchandise had a fair value of $8,000. Prepare the entry to record the repossession.
(Interest Revenue from Installment Sale) Becker Corporation sells farm machinery on the installment plan. On July 1, 2012, Becker entered into an installment sales contract with Valente Inc. for an 8 year period. Equal annual payments under the installment sale are $100,000 and are due on July 1. The first payment was made on July 1, 2012.
Additional information:
1. The amount that would be realized on an outright sale of similar farm machinery is $586,842.
2. The cost of the farm machinery sold to Valente Inc. is $425,000.
3. The finance charges relating to the installment period are based on a stated interest rate of 10%, which is appropriate.
4. Circumstances are such that the collection of the installments due under the contract is reasonably assured.
Instructions
What income or loss before income taxes should Becker record for the year ended December 31, 2012, as a result of the transaction above?
(Installment Sales Method and Cost Recovery Method) Swift Corp., a capital goods manufacturing business that started on January 4, 2012, and operates on a calendar year basis, uses the installment sales method of profit recognition in accounting for all its sales. The following data were taken from the 2012 and 2013 records
2012
2013
Installment sales
$480,000
$620,000
Gross profi t as a percent of costs
25%
28%
Cash collections on sales of 2012
$130,000
$240,000
Cash collections on sales of 2013
–0–
$160,000
The amounts given for cash collections exclude amounts collected for interest charges.
Instructions
(a) Compute the amount of realized gross profit to be recognized on the 2013 income statement, prepared using the installment sales method. (Round percentages to three decimal places.)
(b) State where the balance of Deferred Gross Profit would be reported on the financial statements for 2013.
(c) Compute the amount of realized gross profit to be recognized on the income statement, prepared using the cost recovery method.
(Franchise Entries) Pacific Crossburgers Inc. charges an initial franchise fee of $70,000. Upon the signing of the agreement, a payment of $28,000 is due. Thereafter, three annual payments of $14,000 are required. The credit rating of the franchisee is such that it would have to pay interest at 10% to borrow money.
Instructions
Prepare the entries to record the initial franchise fee on the books of the franchisor under the following assumptions. (Round to the nearest dollar.)
(a) The down payment is not refundable, no future services are required by the franchisor, and collection of the note is reasonably assured.
(b) The franchisor has substantial services to perform, the down payment is refundable, and the collection of the note is very uncertain.
(c) The down payment is not refundable, collection of the note is reasonably certain, the franchisor has yet to perform a substantial amount of services, and the down payment represents a fair measure of the services already performed.
(Franchise Fee, Initial Down Payment) On January 1, 2012, Lesley Benjamin signed an agreement to operate as a franchisee of Campbell Inc. for an initial franchise fee of $50,000. The amount of $10,000 was paid when the agreement was signed, and the balance is payable in five annual payments of $8,000 each, beginning January 1, 2013. The agreement provides that the down payment is not refundable and that no future services are required of the franchisor. Lesley Benjamin’s credit rating indicates that she can borrow money at 11% for a loan of this type.
Instructions
(a) How much should Campbell record as revenue from franchise fees on January 1, 2012? At what amount should Benjamin record the acquisition cost of the franchise on January 1, 2012?
(b) What entry would be made by Campbell on January 1, 2012, if the down payment is refundable and substantial future services remain to be performed by Campbell?
(c) How much revenue from franchise fees would be recorded by Campbell on January 1, 2012, if:
(1) The initial down payment is not refundable, it represents a fair measure of the services already provided, a significant amount of services is still to be performed by Campbell in future periods, and collectibility of the note is reasonably assured?
(2) The initial down payment is not refundable and no future services are required by the franchisor, but collection of the note is so uncertain that recognition of the note as an asset is unwarranted?
(3) The initial down payment has not been earned and collection of the note is so uncertain that recognition of the note as an asset is unwarranted?
(Debt Securities) Presented below is an amortization schedule related to Spangler Company’s 5 year, $100,000 bond with a 7% interest rate and a 5% yield, purchased on December 31, 2010, for $108,660.
Date
Cash Received
Interest Revenue
Bond Premium Amortization
Carrying Amount of Bonds
12/31/10
$108,660
12/31/11
$7,000
$5,433
$1,567
107,093
12/31/12
7,000
5,354
1,646
105,447
12/31/13
7,000
5,272
1,728
103,719
12/31/14
7,000
5,186
1,814
101,905
12/31/15
7,000
5,095
1,905
100,000
The following schedule presents a comparison of the amortized cost and fair value of the bonds at year end.
12/31/11
12/31/12
12/31/13
12/31/14
12/31/15
Amortized cost
$107,093
$105,447
$103,719
$101,905
$100,000
Fair value
$106,500
$107,500
$105,650
$103,000
$100,000
Instructions
(a) Prepare the journal entry to record the purchase of these bonds on December 31, 2010, assuming the bonds are classified as held to maturity securities.
(b) Prepare the journal entry(ies) related to the held to maturity bonds for 2011.
(c) Prepare the journal entry(ies) related to the held to maturity bonds for 2013.
(d) Prepare the journal entry(ies) to record the purchase of these bonds, assuming they are classified as available for sale.
(e) Prepare the journal entry(ies) related to the available for sale bonds for 2011.
(f) Prepare the journal entry(ies) related to the available for sale bonds for 2013.
(Available for Sale Debt Securities) On January 1, 2012, Novotna Company purchased $400,000, 8% bonds of Aguirre Co. for $369,114. The bonds were purchased to yield 10% interest. Interest is payable semiannually on July 1 and January 1. The bonds mature on January 1, 2017. Novotna Company uses the effective interest method to amortize discount or premium. On January 1, 2014, Novotna Company sold the bonds for $370,726 after receiving interest to meet its liquidity needs.
Instructions
(a) Prepare the journal entry to record the purchase of bonds on January 1. Assume that the bonds are classified as available for sale.
(b) Prepare the amortization schedule for the bonds.
(c) Prepare the journal entries to record the semiannual interest on July 1, 2012, and December 31, 2012.
(d) If the fair value of Aguirre bonds is $372,726 on December 31, 2013, prepare the necessary adjusting entry. (Assume the fair value adjustment balance on January 1, 2013, is a debit of $3,375.)
(e) Prepare the journal entry to record the sale of the bonds on January 1, 2014.
(Available for Sale Investments) Cardinal Paz Corp. carries an account in its general ledger called Investments, which contained debits for investment purchases, and no credits, with the following descriptions.
Feb. 1, 2012
Sharapova Company common stock, $100 par, 200 shares
$ 37,400
April 1
U.S. government bonds, 11%, due April 1, 2022, interest payable April 1 and October 1, 110 bonds of $1,000 par each
110,000
July 1
McGrath Company 12% bonds, par $50,000, dated March 1, 2012, purchased at 104 plus accrued interest, interest payable annually on March 1, due March 1, 2032
54,000
Instructions
(Round all computations to the nearest dollar.)
(a) Prepare entries necessary to classify the amounts into proper accounts, assuming that all the securities are classified as available for sale.
(b) Prepare the entry to record the accrued interest and the amortization of premium on December 31, 2012, using the straight line method.
(c) The fair values of the investments on December 31, 2012, were:
Sharapova Company common stock
$ 31,800
U.S. government bonds
124,700
McGrath Company bonds
58,600
What entry or entries, if any, would you recommend be made?
(d) The U.S. government bonds were sold on July 1, 2013, for $119,200 plus accrued interest. Give the proper entry.
(Equity Securities Entries and Disclosures) Parnevik Company has the following securities in its investment portfolio on December 31, 2012 (all securities were purchased in 2012): (1) 3,000 shares of Anderson Co. common stock which cost $58,500, (2) 10,000 shares of Munter Ltd. common stock which cost $580,000, and (3) 6,000 shares of King Company preferred stock which cost $255,000. The Fair Value Adjustment account shows a credit of $10,100 at the end of 2012. In 2013, Parnevik completed the following securities transactions.
1. On January 15, sold 3,000 shares of Anderson’s common stock at $22 per share less fees of $2,150.
2. On April 17, purchased 1,000 shares of Castle’s common stock at $33.50 per share plus fees of $1,980. On December 31, 2013, the market values per share of these securities were: Munter $61, King $40, and Castle $29. In addition, the accounting supervisor of Parnevik told you that, even though all these securities have readily determinable fair values, Parnevik will not actively trade these securities because the top management intends to hold them for more than one year.
Instructions
(a) Prepare the entry for the security sale on January 15, 2013.
(b) Prepare the journal entry to record the security purchase on April 17, 2013.
(c) Compute the unrealized gains or losses and prepare the adjusting entry for Parnevik on December 31, 2013.
(d) How should the unrealized gains or losses be reported on Parnevik’s balance sheet?
(Trading and Available for Sale Securities Entries) McElroy Company has the following portfolio of investment securities at September 30, 2012, its last reporting date.
Trading Securities
Cost
Fair Value
Horton, Inc. common (5,000 shares)
$215,000
$200,000
Monty, Inc. preferred (3,500 shares)
133,000
140,000
Oakwood Corp. common (1,000 shares)
180,000
179,000
On October 10, 2012, the Horton shares were sold at a price of $54 per share. In addition, 3,000 shares of Patriot common stock were acquired at $54.50 per share on November 2, 2012. The December 31, 2012, fair values were: Monty $106,000, Patriot $132,000, and the Oakwood common $193,000. All the securities are classified as trading.
Instructions
(a) Prepare the journal entries to record the sale, purchase, and adjusting entries related to the trading securities in the last quarter of 2012.
(b) How would the entries in part (a) change if the securities were classified as available for sale?
(Available for Sale and Held to Maturity Debt Securities Entries) The following information relates to the debt securities investments of Wildcat Company.
1. On February 1, the company purchased 10% bonds of Gibbons Co. having a par value of $300,000 at 100 plus accrued interest. Interest is payable April 1 and October 1.
2. On April 1, semiannual interest is received.
3. On July 1, 9% bonds of Sampson, Inc. were purchased. These bonds with a par value of $200,000 were purchased at 100 plus accrued interest. Interest dates are June 1 and December 1.
4. On September 1, bonds with a par value of $60,000, purchased on February 1, are sold at 99 plus accrued interest.
5. On October 1, semiannual interest is received.
6. On December 1, semiannual interest is received.
7. On December 31, the fair value of the bonds purchased February 1 and July 1 are 95 and 93, respectively.
Instructions
(a) Prepare any journal entries you consider necessary, including year end entries (December 31), assuming these are available for sale securities.
(b) If Wildcat classified these as held to maturity investments, explain how the journal entries would differ from those in part (a).
(Fair Value and Equity Methods) Brooks Corp. is a medium sized corporation specializing in quarrying stone for building construction. The company has long dominated the market, at one time achieving a 70% market penetration. During prosperous years, the company’s profits, coupled with a conservative dividend policy, resulted in funds available for outside investment. Over the years, Brooks has had a policy of investing idle cash in equity securities. In particular, Brooks has made periodic investments in the company’s principal supplier, Norton Industries. Although the firm currently owns 12% of the outstanding common stock of Norton Industries, Brooks does not have significant influence over the operations of Norton Industries. Cheryl Thomas has recently joined Brooks as assistant controller, and her first assignment is to prepare the 2012 year end adjusting entries for the accounts that are valued by the “fair value” rule for financial reporting purposes. Thomas has gathered the following information about Brooks’s pertinent accounts.
1. Brooks has trading securities related to Delaney Motors and Patrick Electric. During this fiscal year, Brooks purchased 100,000 shares of Delaney Motors for $1,400,000; these shares currently have a market value of $1,600,000. Brooks’ investment in Patrick Electric has not been profitable; the company acquired 50,000 shares of Patrick in April 2012 at $20 per share, a purchase that currently has a value of $720,000.
2. Prior to 2012, Brooks invested $22,500,000 in Norton Industries and has not changed its holdings this year. This investment in Norton Industries was valued at $21,500,000 on December 31, 2011. Brooks’ 12% ownership of Norton Industries has a current market value of $22,225,000.
Instructions
(a) Prepare the appropriate adjusting entries for Brooks as of December 31, 2012, to reflect the application of the “fair value” rule for both classes of securities described above.
(b) For both classes of securities presented above, describe how the results of the valuation adjustments made in (a) would be reflected in the body of and notes to Brooks’ 2012 financial statements.
(c) Prepare the entries for the Norton investment, assuming that Brooks owns 25% of Norton’s shares. Norton reported income of $500,000 in 2012 and paid cash dividends of $100,000.
(Financial Statement Presentation of Available for Sale Investments) Kennedy Company has the following portfolio of available for sale securities at December 31, 2012.
Per Share
Security
Quantity
Percent Interest
Cost
Price
Frank, Inc.
2,000 shares
8%
$11
$16
Ellis Corp.
5,000 shares
14%
23
19
Mendota Company
4,000 shares
2%
31
24
Instructions
(a) What should be reported on Kennedy’s December 31, 2012, balance sheet relative to these long term available for sale securities?
On December 31, 2013, Kennedy’s portfolio of available for sale securities consisted of the following common stocks.
Per Share
Security
Quantity
Percent Interest
Cost
Price
Ellis Corp.
5,000 shares
14%
$23
$28
Mendota Company
4,000 shares
2%
31
23
Mendota Company
2,000 shares
1%
25
23
At the end of year 2013, Kennedy Company changed its intent relative to its investment in Frank, Inc. and reclassified the shares to trading securities status when the shares were selling for $8 per share.
(b) What should be reported on the face of Kennedy’s December 31, 2013, balance sheet relative to available for sale securities investments? What should be reported to reflect the transactions above in Kennedy’s 2013 income statement?
(c) Assuming that comparative financial statements for 2012 and 2013 are presented, draft the footnote necessary for full disclosure of Kennedy’s transactions and position in equity securities.
(Gain on Sale of Investments and Comprehensive Income) On January 1, 2012, Acker Inc. had the following balance sheet.
ACKER INC. BALANCE SHEET AS OF JANUARY 1, 2012
Assets
Equity
Cash
$ 50,000
Common stock
$260,000
Equity investments (available for sale)
240,000
Accumulated other comprehensive income
30,000
Total
$290,000
Total
$290,000
The accumulated other comprehensive income related to unrealized holding gains on available for sale securities. The fair value of Acker Inc.’s available for sale securities at December 31, 2012, was $190,000; its cost was $140,000. No securities were purchased during the year. Acker Inc.’s income statement for 2012 was as follows. (Ignore income taxes.)
ACKER INC. INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 2012
Dividend revenue
$ 5,000
Gain on sale of investments
30,000
Net income
$35,000
Instructions
(Assume all transactions during the year were for cash.)
(a) Prepare the journal entry to record the sale of the available for sale securities in 2012.
(b) Prepare a statement of comprehensive income for 2012.
(c) Prepare a balance sheet as of December 31, 2012.
(Equity Investments—Available for Sale) Castleman Holdings, Inc. had the following available for sale investment portfolio at January 1, 2012.
Evers Company
1,000 shares @ $15 each
$15,000
Rogers Company
900 shares @ $20 each
18,000
Chance Company
500 shares @ $9 each
4,500
Equity investments (available for sale) @ cost
37,500
Fair value adjustment (available for sale)
(7,500)
Equity investments (available for sale) @ fair value
$30,000
During 2012, the following transactions took place.
1. On March 1, Rogers Company paid a $2 per share dividend.
2. On April 30, Castleman Holdings, Inc. sold 300 shares of Chance Company for $11 per share.
3. On May 15, Castleman Holdings, Inc. purchased 100 more shares of Evers Co. stock at $16 per share.
4. At December 31, 2012, the stocks had the following price per share values: Evers $17, Rogers $19, and Chance $8. During 2013, the following transactions took place.
5. On February 1, Castleman Holdings, Inc. sold the remaining Chance shares for $8 per share.
6. On March 1, Rogers Company paid a $2 per share dividend.
7. On December 21, Evers Company declared a cash dividend of $3 per share to be paid in the next month.
8. At December 31, 2013, the stocks had the following price per shares values: Evers $19 and Rogers $21.
Instructions
(a) Prepare journal entries for each of the above transactions.
(b) Prepare a partial balance sheet showing the investment related amounts to be reported at December 31, 2012 and 2013.
(Available for Sale Securities—Statement Presentation) Fernandez Corp. invested its excess cash in available for sale securities during 2012. As of December 31, 2012, the portfolio of available for sale securities consisted of the following common stocks.
Security
Quantity
Cost
Fair Value
Lindsay Jones, Inc.
1,000 shares
$ 15,000
$ 21,000
Poley Corp.
2,000 shares
40,000
42,000
Arnold Aircraft
2,000 shares
72,000
60,000
Total
$127,000
$123,000
Instructions
(a) What should be reported on Fernandez’s December 31, 2012, balance sheet relative to these securities? What should be reported on Fernandez’s 2012 income statement? On December 31, 2013, Fernandez’s portfolio of available for sale securities consisted of the following common stocks.
Security
Quantity
Cost
Fair Value
Lindsay Jones, Inc.
1,000 shares
$ 15,000
$20,000
Lindsay Jones, Inc.
2,000 shares
33,000
40,000
Duff Company
1,000 shares
16,000
12,000
Arnold Aircraft
2,000 shares
72,000
22,000
Total
$136,000
$94,000
During the year 2013, Fernandez Corp. sold 2,000 shares of Poley Corp. for $38,200 and purchased 2,000 more shares of Lindsay Jones, Inc. and 1,000 shares of Duff Company.
(b) What should be reported on Fernandez’s December 31, 2013, balance sheet? What should be reported on Fernandez’s 2013 income statement? On December 31, 2014, Fernandez’s portfolio of available for sale securities consisted of the following common stocks.
Security
Quantity
Cost
Fair Value
Arnold Aircraft
2,000 shares
$72,000
$82,000
Duff Company
500 shares
8,000
6,000
Total
$80,000
$88,000
During the year 2014, Fernandez Corp. sold 3,000 shares of Lindsay Jones, Inc. for $39,900 and 500 shares of Duff Company at a loss of $2,700.
(c) What should be reported on the face of Fernandez’s December 31, 2014, balance sheet? What should be reported on Fernandez’s 2014 income statement?
(d) What would be reported in a statement of comprehensive income at (1) December 31, 2012, and (2) December 31, 2013?
(Derivative Financial Instrument) The treasurer of Miller Co. has read on the Internet that the stock price of Wade Inc. is about to take off. In order to profit from this potential development, Miller Co. purchased a call option on Wade common shares on July 7, 2012, for $240. The call option is for 200 shares (notional value), and the strike price is $70. (The market price of a share of Wade stock on that date is $70.) The option expires on January 31, 2013. The following data are available with respect to the call option.
Date
Market Price of Wade Shares
Time Value of Call Option
September 30, 2012
$77 per share
$180
December 31, 2012
75 per share
65
January 4, 2013
76 per share
30
Instructions
Prepare the journal entries for Miller Co. for the following dates.
(a) July 7, 2012—Investment in call option on Wade shares.
(b) September 30, 2012—Miller prepares financial statements.
(c) December 31, 2012—Miller prepares financial statements.
(d) January 4, 2013—Miller settles the call option on the Wade shares.
(Derivative Financial Instrument) Johnstone Co. purchased a put option on Ewing common shares on July 7, 2012, for $240. The put option is for 200 shares, and the strike price is $70. (The market price of a share of Ewing stock on that date is $70.) The option expires on January 31, 2013. The following data are available with respect to the put option.
Date
Market Price of Ewing Shares
Time Value of Put Option
September 30, 2012
$77 per share
$125
December 31, 2012
75 per share
50
January 31, 2013
78 per share
0
Instructions
Prepare the journal entries for Johnstone Co. for the following dates.
(a) July 7, 2012—Investment in put option on Ewing shares.
(b) September 30, 2012—Johnstone prepares financial statements.
(c) December 31, 2012—Johnstone prepares financial statements.
(Fair Value Hedge Interest Rate Swap) On December 31, 2012, Mercantile Corp. had a $10,000,000, 8% fixed rate note outstanding, payable in 2 years. It decides to enter into a 2 year swap with Chicago First Bank to convert the fixed rate debt to variable rate debt. The terms of the swap indicate that Mercantile will receive interest at a fixed rate of 8.0% and will pay a variable rate equal to the 6 month LIBOR rate, based on the $10,000,000 amount. The LIBOR rate on December 31, 2012, is 7%. The LIBOR rate will be reset every 6 months and will be used to determine the variable rate to be paid for the following 6 month period. Mercantile Corp. designates the swap as a fair value hedge. Assume that the hedging relationship meets all the conditions necessary for hedge accounting. The 6 month LIBOR rate and the swap and debt fair values are as follows.
Date
6 Month LIBOR Rate
Swap Fair Value
Debt Fair Value
December 31, 2012
7.0%
—
$10,000,000
June 30, 2013
7.5%
(200,000)
9,800,000
December 31, 2013
6.0%
60,000
10,060,000
Instructions
(a) Present the journal entries to record the following transactions.
(1) The entry, if any, to record the swap on December 31, 2012.
(2) The entry to record the semiannual debt interest payment on June 30, 2013.
(3) The entry to record the settlement of the semiannual swap amount receivables at 8%, less amount payable at LIBOR, 7%.
(4) The entry to record the change in the fair value of the debt on June 30, 2013.
(5) The entry to record the change in the fair value of the swap at June 30, 2013.
(b) Indicate the amount(s) reported on the balance sheet and income statement related to the debt and swap on December 31, 2012.
(c) Indicate the amount(s) reported on the balance sheet and income statement related to the debt and swap on June 30, 2013.
(d) Indicate the amount(s) reported on the balance sheet and income statement related to the debt and swap on December 31, 2013.
(Cash Flow Hedge) LEW Jewelry Co. uses gold in the manufacture of its products. LEW anticipates that it will need to purchase 500 ounces of gold in October 2012, for jewelry that will be shipped for the holiday shopping season. However, if the price of gold increases, LEW’s cost to produce its jewelry will increase, which would reduce its profit margins.
To hedge the risk of increased gold prices, on April 1, 2012, LEW enters into a gold futures contract and designates this futures contract as a cash flow hedge of the anticipated gold purchase. The notional amount of the contract is 500 ounces, and the terms of the contract give LEW the right and the obligation to purchase gold at a price of $300 per ounce. The price will be good until the contract expires on October 31, 2012. Assume the following data with respect to the price of the call options and the gold inventory purchase.
Date
Spot Price for October Delivery
April 1, 2012
$300 per ounce
June 30, 2012
310 per ounce
September 30, 2012
315 per ounce
Instructions
Prepare the journal entries for the following transactions.
(a) April 1, 2012—Inception of the futures contract, no premium paid.
(b) June 30, 2012—LEW Co. prepares financial statements.
(c) September 30, 2012—LEW Co. prepares financial statements.
(d) October 10, 2012—LEW Co. purchases 500 ounces of gold at $315 per ounce and settles the futures contract.
(e) December 20, 2012—LEW sells jewelry containing gold purchased in October 2012 for $350,000. The cost of the finished goods inventory is $200,000.
(f) Indicate the amount(s) reported on the balance sheet and income statement related to the futures contract on June 30, 2012.
(g) Indicate the amount(s) reported in the income statement related to the futures contract and the inventory transactions on December 31, 2012.
(Fair Value Hedge) On November 3, 2012, Sprinkle Co. invested $200,000 in 4,000 shares of the common stock of Pratt Co. Sprinkle classified this investment as available for sale. Sprinkle Co. is considering making a more significant investment in Pratt Co. at some point in the future but has decided to wait and see how the stock does over the next several quarters. To hedge against potential declines in the value of Pratt stock during this period, Sprinkle also purchased a put option on the Pratt stock. Sprinkle paid an option premium of $600 for the put option, which gives Sprinkle the option to sell 4,000 Pratt shares at a strike price of $50 per share. The option expires on July 31, 2013. The following data are available with respect to the values of the Pratt stock and the put option.
Date
Market Price of Pratt Shares
Time Value of Put Option
December 31, 2012
$50 per share
$375
March 31, 2013
45 per share
175
June 30, 2013
43 per share
40
Instructions
(a) Prepare the journal entries for Sprinkle Co. for the following dates.
(1) November 3, 2012—Investment in Pratt stock and the put option on Pratt shares.
(2) December 31, 2012—Sprinkle Co. prepares financial statements.
(3) March 31, 2013—Sprinkle prepares financial statements.
(4) June 30, 2013—Sprinkle prepares financial statements.
(5) July 1, 2013—Sprinkle settles the put option and sells the Pratt shares for $43 per share.
(b) Indicate the amount(s) reported on the balance sheet and income statement related to the Pratt investment and the put option on December 31, 2012.
(c) Indicate the amount(s) reported on the balance sheet and income statement related to the Pratt investment and the put option on June 30, 2013.
(Issues Raised about Investment Securities) You have just started work for Warren Co. as part of the controller’s group involved in current financial reporting problems. Jane Henshaw, controller for Warren, is interested in your accounting background because the company has experienced a series of financial reporting surprises over the last few years. Recently, the controller has learned from the company’s auditors that there is authoritative literature that may apply to its investment in securities. She assumes that you are familiar with this pronouncement and asks how the following situations should be reported in the financial statements.
Situation 1
Trading securities in the current assets section have a fair value that is $4,200 lower than cost.
Situation 2
A trading security whose fair value is currently less than cost is transferred to the available for sale category.
Situation 3
An available for sale security whose fair value is currently less than cost is classified as noncurrent but is to be reclassified as current.
Situation 4
A company’s portfolio of available for sale securities consists of the common stock of one company. At the end of the prior year, the fair value of the security was 50% of original cost, and this reduction in fair value was reported as other than temporary impairment. However, at the end of the current year the fair value of the security had appreciated to twice the original cost.
Situation 5
The company has purchased some convertible debentures that it plans to hold for less than a year. The fair value of the convertible debentures is $7,700 below its cost.
Instructions
What is the effect upon carrying value and earnings for each of the situations above? Assume that these situations are unrelated.
(Equity Securities) Lexington Co. has the following available for sale securities outstanding on December 31, 2012 (its first year of operations).
Cost
Fair Value
Greenspan Corp. Stock
$20,000
$19,000
Summerset Company Stock
9,500
8,800
Tinkers Company Stock
20,000
20,600
$49,500
$48,400
During 2013, Summerset Company stock was sold for $9,200, the difference between the $9,200 and the “fair value” of $8,800 being recorded as a “Gain on Sale of Investments.” The market price of the stock on December 31, 2013, was: Greenspan Corp. stock $19,900; Tinkers Company stock $20,500.
Instructions
(a) What justification is there for valuing available for sale securities at fair value and reporting the unrealized gain or loss as part of stockholders’ equity?
(b) How should Lexington Company apply this rule on December 31, 2012? Explain.
(c) Did Lexington Company properly account for the sale of the Summerset Company stock? Explain.
(d) Are there any additional entries necessary for Lexington Company at December 31, 2013, to reflect the facts on the financial statements in accordance with generally accepted accounting principles? Explain.
(Financial Statement Effect of Equity Securities) Presented below are three unrelated situations involving equity securities.
Situation 1
An equity security, whose fair value is currently less than cost, is classified as available for sale but is to be reclassified as trading.
Situation 2
A noncurrent portfolio with an aggregate fair value in excess of cost includes one particular security whose fair value has declined to less than one half of the original cost. The decline in value is considered to be other than temporary.
Situation 3
The portfolio of trading securities has a cost in excess of fair value of $13,500. The available for sale portfolio has a fair value in excess of cost of $28,600.
Instructions
What is the effect upon carrying value and earnings for each of the situations above?
(Equity Investment) On July 1, 2012, Selig Company purchased for cash 40% of the outstanding capital stock of Spoor Corporation. Both Selig and Spoor have a December 31 year end. Spoor Corporation, whose common stock is actively traded on the American Stock Exchange, paid a cash dividend on November 15, 2012, to Selig Company and its other stockholders. It also reported its total net income for the year of $920,000 to Selig Company.
Instructions
Prepare a one page memorandum of instructions on how Selig Company should report the above facts in its December 31, 2012, balance sheet and its 2012 income statement. In your memo, identify and describe the method of valuation you recommend. Provide rationale where you can. Address your memo to the chief accountant at Selig Company.
(Investment Classifications) For the following investments, identify whether they are:
1. Trading
2. Available for Sale
3. Held to Maturity
Each case is independent of the other.
(a) A bond that will mature in 4 years was bought 1 month ago when the price dropped. As soon as the value increases, which is expected next month, it will be sold.
(b) 10% of the outstanding stock of Farm Co was purchased. The company is planning on eventually getting a total of 30% of its outstanding stock.
(c) 10 year bonds were purchased this year. The bonds mature at the first of next year.
(d) Bonds that will mature in 5 years are purchased. The company would like to hold them until they mature, but money has been tight recently and they may need to be sold.
(e) A bond that matures in 10 years was purchased. The company is investing money set aside for an expansion project planned 10 years from now.
(f) Preferred stock was purchased for its constant dividend. The company is planning to hold the preferred stock for a long time.
(Entries for Held to Maturity Securities) On January 1, 2011, Roosevelt Company purchased 12% bonds, having a maturity value of $500,000, for $537,907.40. The bonds provide the bondholders with a 10% yield. They are dated January 1, 2011, and mature January 1, 2016, with interest receivable December 31 of each year. Roosevelt Company uses the effective interest method to allocate unamortized discount or premium. The bonds are classified in the held to maturity category.
Instructions
(a) Prepare the journal entry at the date of the bond purchase.
(b) Prepare a bond amortization schedule.
(c) Prepare the journal entry to record the interest received and the amortization for 2011.
(d) Prepare the journal entry to record the interest received and the amortization for 2012.
(Entries for Available for Sale Securities) Assume the same information as in E17 3 except that the securities are classified as available for sale. The fair value of the bonds at December 31 of each year end is as follows.
2011
$534,200
2012
$515,000
2013
$513,000
2014
$517,000
2015
$500,000
Instructions
(a) Prepare the journal entry at the date of the bond purchase.
(b) Prepare the journal entries to record the interest received and recognition of fair value for 2011.
(c) Prepare the journal entry to record the recognition of fair value for 2012.
(Effective Interest versus Straight Line Bond Amortization) On January 1, 2012, Morgan Company acquires $300,000 of Nicklaus, Inc., 9% bonds at a price of $278,384. The interest is payable each December 31, and the bonds mature December 31, 2014. The investment will provide Morgan Company a 12% yield. The bonds are classified as held to maturity.
Instructions
(a) Prepare a 3 year schedule of interest revenue and bond discount amortization, applying the straight line method. (Round to nearest dollar.)
(b) Prepare a 3 year schedule of interest revenue and bond discount amortization, applying the effective interest method. (Round to nearest cent.)
(c) Prepare the journal entry for the interest receipt of December 31, 2013, and the discount amortization under the straight line method.
(d) Prepare the journal entry for the interest receipt of December 31, 2013, and the discount amortization under the effective interest method.
(Trading Securities Entries) On December 21, 2012, Zurich Company provided you with the following information regarding its trading securities.
Investments (Trading)
Cost
Fair Value
Unrealized Gain (Loss)
Stargate Corp. stock
$20,000
$19,000
$(1,000)
Carolina Co. stock
10,000
9,000
(1,000)
Vectorman Co. stock
20,000
20,600
600
Total of portfolio
$50,000
$48,600
(1,400)
Previous fair value adjustment balance
–0–
Fair value adjustment—Cr.
$(1,400)
During 2013, Carolina Company stock was sold for $9,500. The fair value of the stock on December 31, 2013, was: Stargate Corp. stock—$19,300; Vector man Co. stock—$20,500.
Instructions
(a) Prepare the adjusting journal entry needed on December 31, 2012.
(b) Prepare the journal entry to record the sale of the Carolina Company stock during 2013.
(c) Prepare the adjusting journal entry needed on December 31, 2013.
(Available for Sale Securities Entries and Financial Statement Presentation) At December 31, 2012, the available for sale equity portfolio for Wenger, Inc. is as follows.
Security
Cost
Fair Value
Unrealized Gain (Loss)
A
$17,500
$15,000
($2,500)
B
12,500
14,000
1,500
C
23,000
25,500
2,500
Total
$53,000
$54,500
1,500
Previous fair value adjustment balance—Dr.
200
Fair value adjustment—Dr.
$1,300
On January 20, 2013, Wenger, Inc. sold security A for $15,300. The sale proceeds are net of brokerage fees.
Instructions
(a) Prepare the adjusting entry at December 31, 2012, to report the portfolio at fair value.
(b) Show the balance sheet presentation of the investment related accounts at December 31, 2012.
(c) Prepare the journal entry for the 2013 sale of security A.
(Equity Securities Entries) Capriati Corporation made the following cash purchases of securities during 2012, which is the first year in which Capriati invested in securities.
1. On January 15, purchased 9,000 shares of Gonzalez Company’s common stock at $33.50 per share plus commission $1,980.
2. On April 1, purchased 5,000 shares of Belmont Co.’s common stock at $52.00 per share plus commission $3,370.
3. On September 10, purchased 7,000 shares of Thep Co.’s preferred stock at $26.50 per share plus commission $4,910. On May 20, 2012, Capriati sold 3,000 shares of Gonzalez Company’s common stock at a market price of $35 per share less brokerage commissions, taxes, and fees of $2,850. The year end fair values per share were: Gonzalez $30, Belmont $55, and Thep $28. In addition, the chief accountant of Capriati told you that Capriati Corporation plans to hold these securities for the long term but may sell them in order to earn profits from appreciation in prices.
Instructions
(a) Prepare the journal entries to record the above three security purchases.
(b) Prepare the journal entry for the security sale on May 20.
(c) Compute the unrealized gains or losses and prepare the adjusting entries for Capriati on December 31, 2012.
(Journal Entries for Fair Value and Equity Methods) Presented on page 1032 are two independent situations.
Situation 1
Hatcher Cosmetics acquired 10% of the 200,000 shares of common stock of Ramirez Fashion at a total cost of $14 per share on March 18, 2012. On June 30, Ramirez declared and paid a $75,000 cash dividend. On December 31, Ramirez reported net income of $122,000 for the year. At December 31, the market price of Ramirez Fashion was $15 per share. The securities are classified as available for sale.
Situation 2
Holmes, Inc. obtained significant influence over Nadal Corporation by buying 25% of Nadal’s 30,000 outstanding shares of common stock at a total cost of $9 per share on January 1, 2012. On June 15, Nadal declared and paid a cash dividend of $36,000. On December 31, Nadal reported a net income of $85,000 for the year.
Instructions
Prepare all necessary journal entries in 2012 for both situations.
(Equity Method) Gator Co. invested $1,000,000 in Demo Co. for 25% of its outstanding stock. Demo Co. pays out 40% of net income in dividends each year.
Instructions
Use the information in the following T account for the investment in Demo to answer the following questions.
Equity Investments (Demo Co.)
1,000,000
130,000
52,000
(a) How much was Gator Co.’s share of Demo Co.’s net income for the year?
(b) How much was Gator Co.’s share of Demo Co.’s dividends for the year?
(c) What was Demo Co.’s total net income for the year?
(d) What were Demo Co.’s total dividends for the year?
(Fair Value and Equity Method Compared) Gregory Inc. acquired 20% of the outstanding common stock of Handerson Inc. on December 31, 2012. The purchase price was $1,250,000 for 50,000 shares. Handerson Inc. declared and paid an $0.80 per share cash dividend on June 30 and on December 31, 2013. Handerson reported net income of $730,000 for 2013. The fair value of Handerson’s stock was $27 per share at December 31, 2013.
Instructions
(a) Prepare the journal entries for Gregory Inc. for 2012, and 2013, assuming that Gregory cannot exercise significant influence over Handerson. The securities should be classified as available for sale.
(b) Prepare the journal entries for Gregory Inc. for 2012 and 2013, assuming that Gregory can exercise significant influence over Handerson.
(c) At what amount is the investment in securities reported on the balance sheet under each of these methods at December 31, 2013? What is the total net income reported in 2013 under each of these methods?
(Impairment of Debt Securities) Cairo Corporation has municipal bonds classified as available for sale at December 31, 2012. These bonds have a par value of $800,000, an amortized cost of $800,000, and a fair value of $740,000. The unrealized loss of $60,000 previously recognized as other comprehensive income and as a separate component of stockholders’ equity is now determined to be other than temporary. That is, the company believes that impairment accounting is now appropriate for these bonds.
Instructions
(a) Prepare the journal entry to recognize the impairment.
(b) What is the new cost basis of the municipal bonds? Given that the maturity value of the bonds is $800,000, should Cairo Corporation amortize the difference between the carrying amount and the maturity value over the life of the bonds?
(c) At December 31, 2013, the fair value of the municipal bonds is $760,000. Prepare the entry (if any) to record this information.
(Fair Value Measurement) Presented below is information related to the purchases of common stock by Lilly Company during 2012.
Cost (at purchase date)
Fair Value (at December 31)
Investment in Arroyo Company stock
$100,000
$ 80,000
Investment in Lee Corporation stock
250,000
300,000
Investment in Woods Inc. stock
180,000
190,000
Total
$530,000
$570,000
Instructions
(a) What entry would Lilly make at December 31, 2012, to record the investment in Arroyo Company stock if it chooses to report this security using the fair value option?
(b) What entry would Lilly make at December 31, 2012, to record the investment in Lee Corporation, assuming that Lilly wants to classify this security as available for sale? This security is the only available for sale security that Lilly presently owns.
(c) What entry would Lilly make at December 31, 2012, to record the investment in Woods Inc., assuming that Lilly wants to classify this investment as a trading security?
(Fair Value Measurement Issues) Assume the same information as in E17 19 for Lilly Company. In addition, assume that the investment in the Woods Inc. stock was sold during 2013 for $195,000. At December 31, 2013, the following information relates to its two remaining investments of common stock.
Cost at purchase date)
Fair Value (at December 31)
Investment in Arroyo Company stock
$100,000
$140,000
Investment in Lee Corporation stock
250,000
310,000
Total
$350,000
$450,000
Net income before any security gains and losses for 2013 was $905,000.
Instructions
(a) Compute the amount of net income or net loss that Lilly should report for 2013, taking into consideration Lilly’s security transactions for 2013.
(b) Prepare the journal entry to record unrealized gain or loss related to the investment in Arroyo Company stock at December 31, 2013.
(Fair Value Option) Presented below is selected information related to the financial instruments of Dawson Company at December 31, 2012. This is Dawson Company’s first year of operations.
Carrying Amount
Fair Value (at December 31)
Investment in debt securities (intent is to hold to maturity)
$ 40,000
$ 41,000
Investment in Chen Company stock
800,000
910,000
Bonds payable
220,000
195,000
Instructions
(a) Dawson elects to use the fair value option whenever possible. Assuming that Dawson’s net income is $100,000 in 2012 before reporting any securities gains or losses, determine Dawson’s net income for 2012.
(b) Record the journal entry, if any, necessary at December 31, 2012, to record the fair value option for the bonds payable.
(Derivative Transaction) On January 2, 2012, Jones Company purchases a call option for $300 on Merchant common stock. The call option gives Jones the option to buy 1,000 shares of Merchant at a strike price of $50 per share. The market price of a Merchant share is $50 on January 2, 2012 (the intrinsic value is therefore $0). On March 31, 2012, the market price for Merchant stock is $53 per share, and the time value of the option is $200.
Instructions
(a) Prepare the journal entry to record the purchase of the call option on January 2, 2012.
(b) Prepare the journal entry (ies) to recognize the change in the fair value of the call option as of March 31, 2012.
(c) What was the effect on net income of entering into the derivative transaction for the period January 2 to March 31, 2012?
(Fair Value Hedge) Sarazan Company issues a 4 year, 7.5% fixed rate interest only, non prepayable $1,000,000 note payable on December 31, 2012. It decides to change the interest rate from a fixed rate to variable rate and enters into a swap agreement with M&S Corp. The swap agreement specifies that Sarazan will receive a fixed rate at 7.5% and pay variable with settlement dates that match the interest payments on the debt. Assume that interest rates have declined during 2013 and that Sarazan received $13,000 as an adjustment to interest expense for the settlement at December 31, 2013. The loss related to the debt (due to interest rate changes) was $48,000. The value of the swap contract increased $48,000.
Instructions
(a) Prepare the journal entry to record the payment of interest expense on December 31, 2013.
(b) Prepare the journal entry to record the receipt of the swap settlement on December 31, 2013.
(c) Prepare the journal entry to record the change in the fair value of the swap contract on December 31, 2013.
(d) Prepare the journal entry to record the change in the fair value of the debt on December 31, 2013.
(Call Option) On August 15, 2012, Outkast Co. invested idle cash by purchasing a call option on Counting Crows Inc. common shares for $360. The notional value of the call option is 400 shares, and the option price is $40. (Market price of an Outkast share is $40.) The option expires on January 31, 2013. The following data are available with respect to the call option.
Date
Market Price of Counting Crows Shares
Time Value of Call Option
September 30, 2012
$48 per share
$180
December 31, 2012
$46 per share
65
January 15, 2013
$47 per share
30
Instructions
Prepare the journal entries for Outkast for the following dates.
(a) Investment in call option on Counting Crows shares on August 15, 2012.
(b) September 30, 2012—Outkast prepares financial statements.
(c) December 31, 2012—Outkast prepares financial statements.
(d) January 15, 2013—Outkast settles the call option on the Counting Crows shares.
(Cash Flow Hedge) Hart Golf Co. uses titanium in the production of its specialty drivers. Hart anticipates that it will need to purchase 200 ounces of titanium in October 2012, for clubs that will be shipped in the holiday shopping season. However, if the price of titanium increases, this will increase the cost to produce the clubs, which will result in lower profit margins. To hedge the risk of increased titanium prices, on May 1, 2012, Hart enters into a titanium futures contract and designates this futures contract as cash flow hedge of the anticipated titanium purchase. The notional amount of the contract is 200 ounces, and the terms of the contract give Hart the right and the obligation to purchase titanium at a price of $500 per ounce. The price will be good until the contract expires on November 30, 2012. Assume the following data with respect to the price of the call options and the titanium inventory purchase.
Date
Spot Price for November Delivery
May 1, 2012
$500 per ounce
June 30, 2012
520 per ounce
September 30, 2013
525 per ounce
Instructions
Present the journal entries for the following dates/transactions.
(a) May 1, 2012—Inception of futures contract, no premium paid.
(b) June 30, 2012—Hart prepares financial statements.
(c) September 30, 2012—Hart prepares financial statements.
(d) October 5, 2012—Hart purchases 200 ounces of titanium at $525 per ounce and settles the futures contract.
(e) December 15, 2012—Hart sells clubs containing titanium purchased in October 2012 for $250,000. The cost of the finished goods inventory is $140,000.
(f) Indicate the amount(s) reported in the income statement related to the futures contract and the inventory transactions on December 31, 2012.
The following financial data were reported by 3M Company for 2007 and 2008 (dollars in millions).
2008
2007
Current assets
Cash and cash equivalents
$1,849
$1,896
Accounts receivable, net
3,195
3,362
Inventories
3,013
2,852
Other current assets
1,541
1,728
Total current assets
$9,598
$9,838
Current liabilities
$5,839
$5,362
Instructions
(a) Calculate the current ratio and working capital for 3M for 2007 and 2008.
(b) Suppose at the end of 2008, 3M management used $300 million cash to pay off $300 million of accounts payable. How would the current ratio and working capital have changed?
The following section is taken from Budke Corp.’s balance sheet at December 31, 2010.
Current liabilities
Bond interest payable
$ 72,000
Long term liabilities
Bonds payable, 9%, due January 1, 2015
1,600,000
Interest is payable semiannually on January 1 and July 1.The bonds are callable on any interest date.
Instructions
(a) Journalize the payment of the bond interest on January 1, 2011.
(b) Assume that on January 1, 2011, after paying interest, Budke calls bonds having a face value of $600,000.The call price is 104. Record the redemption of the bonds.
(c) Prepare the entry to record the payment of interest on July 1, 2011, assuming no previous accrual of interest on the remaining bonds.
1. Sigel Corporation retired $130,000 face value, 12% bonds on June 30, 2011, at 102.The carrying value of the bonds at the redemption date was $117,500.The bonds pay semiannual interest, and the interest payment due on June 30, 2011, has been made and recorded.
2. Diaz Inc. retired $150,000 face value, 12.5% bonds on June 30, 2011, at 98.The carrying value of the bonds at the redemption date was $151,000.The bonds pay semiannual interest, and the interest payment due on June 30, 2011, has been made and recorded.
3. Haas Company has $80,000, 8%, 12 year convertible bonds outstanding. These bonds were sold at face value and pay semiannual interest on June 30 and December 31 of each year.The bonds are convertible into 30 shares of Haas $5 par value common stock for each $1,000 worth of bonds. On December 31, 2011, after the bond interest has been paid, $20,000 face value bonds were converted. The market value of Haas common stock was $44 per share on December 31, 2011.
Instructions
For each independent situation above, prepare the appropriate journal entry for the redemption or conversion of the bonds.
On May 1, 2011, Newby Corp. issued $600,000, 9%, 5 year bonds at face value. The bonds were dated May 1, 2011, and pay interest semiannually on May 1 and November 1. Financial statements are prepared annually on December 31.
Instructions
(a) Prepare the journal entry to record the issuance of the bonds.
(b) Prepare the adjusting entry to record the accrual of interest on December 31, 2011.
(c) Show the balance sheet presentation on December 31, 2011.
(d) Prepare the journal entry to record payment of interest on May 1, 2012, assuming no accrual of interest from January 1, 2012, to May 1, 2012.
(e) Prepare the journal entry to record payment of interest on November 1, 2012.
(f) Assume that on November 1, 2012, Newby calls the bonds at 102. Record the redemption of the bonds.
On July 1, 2011, Atwater Corporation issued $2,000,000 face value, 10%, 10 year bonds at $2,271,813.This price resulted in an effective interest rate of 8% on the bonds. Atwater uses the effective interest method to amortize bond premium or discount. The bonds pay semiannual interest July 1 and January 1.
Instructions
(Round all computations to the nearest dollar.)
(a) Prepare the journal entry to record the issuance of the bonds on July 1, 2011.
(b) Prepare an amortization table through December 31, 2012 (3 interest periods) for this bond issue.
(c) Prepare the journal entry to record the accrual of interest and the amortization of the premium on December 31, 2011.
(d) Prepare the journal entry to record the payment of interest and the amortization of the premium on July 1, 2012, assuming no accrual of interest on June 30.
(e) Prepare the journal entry to record the accrual of interest and the amortization of the premium on December 31, 2012.
On July 1, 2011, Rossillon Company issued $4,000,000 face value, 8%, 10 year bonds at $3,501,514.This price resulted in an effective interest rate of 10% on the bonds. Rossillon uses the effective interest method to amortize bond premium or discount.The bonds pay semiannual interest July 1 and January 1. Instructions
(Round all computations to the nearest dollar.)
(a) Prepare the journal entries to record the following transactions.
(1) The issuance of the bonds on July 1, 2011.
(2) The accrual of interest and the amortization of the discount on December 31, 2011.
(3) The payment of interest and the amortization of the discount on July 1, 2012, assuming no accrual of interest on June 30.
(4) The accrual of interest and the amortization of the discount on December 31, 2012.
(b) Show the proper balance sheet presentation for the liability for bonds payable on the December 31, 2012, balance sheet.
(c) Provide the answers to the following questions in letter form.
(1) What amount of interest expense is reported for 2012?
(2) Would the bond interest expense reported in 2012 be the same as, greater than, or less than the amount that would be reported if the straight line method of amortization wereused?
(3) Determine the total cost of borrowing over the life of the bond.
(4) Would the total bond interest expense be greater than, the same as, or less than the total interest expense that would be reported if the straight line method of amortization were used?
The following is taken from the Pinkston Company balance sheet.
PINKSTON COMPANY
Balance Sheet (partial)
December 31, 2011
Current liabilities
Bond interest payable (for 6 months
from July 1 to December 31)
$ 105,000
Long term liabilities
Bonds payable, 7% due January 1, 2022
$3,000,000
Add: Premium on bonds payable
200,000
$3,200,000
Interest is payable semiannually on January 1 and July 1. The bonds are callable on any semiannual interest date. Pinkston uses straight line amortization for any bond premium or discount. From December 31, 2011, the bonds will be outstanding for an additional 10 years (120 months).
Instructions
(a) Journalize the payment of bond interest on January 1, 2012.
(b) Prepare the entry to amortize bond premium and to pay the interest due on July 1, 2012, assuming no accrual of interest on June 30.
(c) Assume that on July 1, 2012, after paying interest, Pinkston Company calls bonds having a face value of $1,200,000.The call price is 101. Record the redemption of the bonds.
(d) Prepare the adjusting entry at December 31, 2012, to amortize bond premium and to accrue interest on the remaining bonds.
On July 1, 2011, Matlock Satellites issued $2,700,000 face value, 9%, 10 year bonds at $2,531,760.This price resulted in an effective interest rate of 10% on the bonds. Matlock uses the effective interest method to amortize bond premium or discount.The bonds pay semiannual interest July 1 and January 1.
Instructions
(Round all computations to the nearest dollar.)
(a) Prepare the journal entry to record the issuance of the bonds on July 1, 2011.
(b) Prepare an amortization table through December 31, 2012 (3 interest periods) for this bond issue.
(c) Prepare the journal entry to record the accrual of interest and the amortization of the discount on December 31, 2011.
(d) Prepare the journal entry to record the payment of interest and the amortization of the discount on July 1, 2012, assuming that interest was not accrued on June 30.
(e) Prepare the journal entry to record the accrual of interest and the amortization of the discount on December 31, 2012.
On July 1, 2011, S. Posadas Chemical Company issued $3,000,000 face value, 10%, 10 year bonds at $3,407,720. This price resulted in an 8% effective interest rate on the bonds. Posadas uses the effective interest method to amortize bond premium or discount. The bondspay semiannual interest on each July 1 and January 1.
Instructions
(Round all computations to the nearest dollar.)
(a) Prepare the journal entries to record the following transactions.
(1) The issuance of the bonds on July 1, 2011.
(2) The accrual of interest and the amortization of the premium on December 31, 2011.
(3) The payment of interest and the amortization of the premium on July 1, 2012, assuming no accrual of interest on June 30.
(4) The accrual of interest and the amortization of the premium on December 31, 2012.
(b) Show the proper balance sheet presentation for the liability for bonds payable on the December 31, 2012, balance sheet.
(c) Provide the answers to the following questions in letter form.
(1) What amount of interest expense is reported for 2012?
(2) Would the bond interest expense reported in 2012 be the same as, greater than, or less than the amount that would be reported if the straight line method of amortization were used?
(3) Determine the total cost of borrowing over the life of the bond.
(4) Would the total bond interest expense be greater than, the same as, or less than the total interest expense if the straight line method of amortization were used?
The following is taken from the Magana Corp. balance sheet.
MAGANA CORPORATION
Balance Sheet (partial)
December 31, 2011
Current liabilities
Bond interest payable (for 6 months
from July 1 to December 31)
$ 84,000
Long term liabilities
Bonds payable, 7%, due
January 1, 2022
$2,400,000
Less: Discount on bonds payable
90,000
$2,310,000
Interest is payable semiannually on January 1 and July 1.The bonds are callable on any semiannual interest date. Magana uses straight line amortization for any bond premium or discount. From December 31, 2011, the bonds will be outstanding for an additional 10 years (120 months).
Instructions
(Round all computations to the nearest dollar).
(a) Journalize the payment of bond interest on January 1, 2012.
(b) Prepare the entry to amortize bond discount and to pay the interest due on July 1, 2012, assuming that interest was not accrued on June 30.
(c) Assume that on July 1, 2012, after paying interest, Magana Corp. calls bonds having a face value of $800,000.The call price is 101. Record the redemption of the bonds.
(d) Prepare the adjusting entry at December 31, 2012, to amortize bond discount and to accrue interest on the remaining bonds.
Aber Corporation’s balance sheet at December 31, 2010, is presented below.
ABER CORPORATION
Balance Sheet
December 31, 2010
Cash
$30,500
Accounts payable
$13,750
Inventory
25,750
Bond interest payable
3,000
Prepaid insurance
5,600
Bonds payable
50,000
Equipment
38,000
Common stock
20,000
$99,850
Retained earnings
$13,100
During 2011, the following transactions occurred.
1. Aber paid $3,000 interest on the bonds on January 1, 2011.
2. Aber purchased $241,100 of inventory on account.
3. Aber sold for $450,000 cash inventory which cost $250,000.Aber also collected $27,000 sales taxes.
4. Aber paid $230,000 on accounts payable.
5. Aber paid $3,000 interest on the bonds on July 1, 2011.
6. The prepaid insurance ($5,600) expired on July 31.
7. On August 1, Aber paid $10,200 for insurance coverage from August 1,2011,through July 31,2012.
8. Aber paid $17,000 sales taxes to the state.
9. Paid other operating expenses, $91,000.
10. Retired the bonds on December 31, 2011, by paying $48,000 plus $3,000 interest.
11. Issued $90,000 of 8% bonds on December 31, 2011, at 104. The bonds pay interest every June 30 and December 31.
Adjustment data:
1. Recorded the insurance expired from item 7.
2. The equipment was acquired on December 31, 2010, and will be depreciated on a straight line basis over 5 years with a $3,000 salvage value.
3. The income tax rate is 30%. (Hint: Prepare the income statement up to income before taxes and multiply by 30% to compute the amount.)
Instructions
(You may want to set up T accounts to determine ending balances.)
(a) Prepare journal entries for the transactions listed above and adjusting entries.
(b) Prepare an adjusted trial balance at December 31, 2011.
(c) Prepare an income statement and a retained earnings statement for the year ending December 31, 2011, and a classified balance sheet as of December 31, 2011.
Paris Company and Troyer Company are competing businesses. Both began operations 6 years ago and are quite similar in most respects. The current balance sheet data for the two companies are shown below.
Paris
Troyer
Company
Company
Cash
$ 70,300
$ 48,400
Accounts receivable
309,700
312,500
Allowance for doubtful accounts
(13,600)
–0–
Merchandise inventory
463,900
520,200
Plant and equipment
255,300
257,300
Accumulated depreciation, plant and equipment
(112,650)
(189,850)
Total assets
972,950
$948,550
Current liabilities
$440,200
$436,500
Long term liabilities
78,000
80,000
Total liabilities
518,200
516,500
Stockholders’ equity
454,750
432,050
Total liabilities and stockholders’ equity
$972,950
$948,550
You have been engaged as a consultant to conduct a review of the two companies. Your goal is to determine which of them is in the stronger financial position. Your review of their financial statements quickly reveals that the two companies have not followed the same accounting practices.The differences and your conclusions regarding them are summarized below.
1. Paris Company has used the allowance method of accounting for bad debts. A review shows that the amount of its write offs each year has been quite close to the allowances that have been provided. It therefore seems reasonable to have confidence in its current estimate of bad debts. Troyer Company has used the direct write off method for bad debts, and it has been somewhat slow to write off its uncollectible accounts. Based upon an aging analysis and review of its accounts receivable, it is estimated that $20,000 of its existing accounts will prob ably prove to be uncollectible.
2. Paris Company has determined the cost of its merchandise inventory on a LIFO basis. The result is that its inventory appears on the balance sheet at an amount that is below its current replacement cost. Based upon a detailed physical examination of its merchandise on hand, th current replacement cost of its inventory is estimated at $517,000. Troyer Company has used the FIFO method of valuing its merchandise inventory. Its ending inventory appears on the balance sheet at an amount that quite closely approximates its current replacement cost.
3. Paris Company estimated a useful life of 12 years and a salvage value of $30,000 for its plant and equipment. It has been depreciating them on a straight line basis. Troyer Company has the same type of plant and equipment. However, it estimated a useful life of 10 years and a salvage value of $10,000. It has been depreciating its plant and equipment using the double declining balance method. Based upon engineering studies of these types of plant and equipment, you conclude that Troyer’s estimates and method for calculating depreciation are the more appropriate.
4. Among its current liabilities, Paris has included the portions of long term liabilities that become due within the next year.Troyer has not done so. You find that $16,000 of Troyer’s $80,000 of long term liabilities are due to be repaid in the current year.
Instructions
(a) Revise the balance sheets presented above so that the data are comparable and reflect the current financial position for each of the two companies.
(b) Prepare a brief report to your client stating your conclusions.
The financial statements of PepsiCo and the Notes to Consolidated Financial Statements appear in Appendix A.
Instructions
Refer to PepsiCo’s financial statements and answer the following questions about current and long term liabilities.
(a) What were PepsiCo’s total current liabilities at December 27, 2008? What was the increase/decrease in PepsiCo’s total current liabilities from the prior year?
(b) In PepsiCo’s Note 2 (“Our Significant Accounting Policies”), the company explains the nature of its contingencies. Under what conditions does PepsiCo recognize (record and report) liabilities for contingencies?
(c) What were the components of total current liabilities on December 27, 2008?
(d) What was PepsiCo’s total long term debt (excluding deferred income taxes) at December 27, 2008? What was the increase/decrease in total long term debt (excluding deferred income taxes) from the prior year? What does Note 9 to the financial statements indicate about the composition of PepsiCo’s long term debt obligation?
(e) What are the total long term contractual commitments that PepsiCo reports as of December 27, 2008? (See Note 9.)
PepsiCo’s financial statements are presented in Appendix A. Coca Cola’s financial statements are presented in Appendix B.
Instructions
(a) At December 27, 2008, what was PepsiCo’s largest current liability account? What were its total current liabilities? At December 31, 2008, what was Coca Cola’s largest current liability account? What were its total current liabilities?
(b) Based on information contained in those financial statements, compute the following 2008 values for each company.
(1) Working capital.
(2) Current ratio.
(c) What conclusions concerning the relative liquidity of these companies can be drawn from these data?
(d) Based on the information contained in these financial statements, compute the following 2008 ratios for each company.
(1) Debt (excluding “deferred income taxes”) to total assets.
(2) Times interest earned.
(e) What conclusions concerning the companies’ long run solvency can be drawn from these ratios?
On January 1, 2009, Bailey Corporation issued $6,000,000 of 5 year, 8% bonds at 96. The bonds pay interest semiannually on July 1 and January 1. By January 1, 2011, the market rate of interest for bonds of similar risk had risen. As a result, the market value of the Bailey Corporation bonds was $5,000,000 on January 1, 2011—below their carrying value. Debbie Bailey, president of the company, suggests repurchasing all of these bonds in the open market at the $5,000,000 price.To do so, the company would have to issue $5,000,000 (face value) of new 10 year, 11% bonds at par. The president asks you, as controller, “What is the feasibility of my proposed repurchase plan?”
Instructions
With the class divided into groups, answer the following.
*(a) What is the carrying value of the outstanding Bailey Corporation 5 year bonds on January 1, 2011? (Assume straight line amortization.)
(b) Prepare the journal entry to retire the 5 year bonds on January 1, 2011. Prepare the journal entry to issue the new 10 year bonds.
(c) Prepare a list of talking points for your use in meeting with the president in response to her request for advice. List the economic factors that you believe should be considered for her repurchase proposal.
As indicated in the “All About You” feature in this chapter (page 468), medical costs are substantial and rising. But will medical costs be your most substantial expense over your lifetime? Not likely.Will it be housing or food? Again, not likely. The answer is in the Accounting Across the Organization box on page 450. On average, Americans work 74 days to afford their federal taxes. Companies, too, have large tax burdens. They look very hard at tax issues in deciding where to build their plants and where to locate their administrative headquarters.
Instructions
(a) Determine what your state income taxes are if your taxable income is $60,000 and you file as a single taxpayer in the state in which you live.
(b) Assume that you own a home worth $200,000 in your community and the tax rate is 2.1%. Compute the property taxes you would pay.
(c) Assume that the total gasoline bill for your automobile is $1,200 a year (400 gallons at $3 per gallon).What are the amounts of state and federal taxes that you pay on the $1,200?
(d) Assume that your purchases for the year total $9,000. Of this amount, $5,000 was for food and prescription drugs.What is the amount of sales tax you would pay on these purchases? (Note that many states do not have a sales tax for food or prescription drug purchases. Does yours?).
(e) Determine what your Social Security taxes are if your income is $60,000.
(f) Determine what your federal income taxes are if your taxable income is $60,000 and you file as a single taxpayer.
(g) Determine your total taxes paid based on the above calculations, and determine the percentage of income that you would pay in taxes based on the following formula:Total taxes paid _ Total income.
At the beginning of 2009, Anfernee Company acquired equipment costing $200,000. It was estimated that this equipment would have a useful life of 6 years and a residual value of $20,000 at that time.The straight line method of depreciation was considered the most appropriate to use with this type of equipment. Depreciation is to be recorded at the end of each year. During 2011 (the third year of the equipment’s life), the company’s engineers reconsidered their expectations, and estimated that the equipment’s useful life would probably be 7 years (in total) instead of 6 years. The estimated residual value was not changed at that time. However, during 2014 the estimated residual value was reduced to $5,000.
Instructions
Indicate how much depreciation expense should be recorded for this equipment each year by completing the following table.
At December 31, 2011, Starkey Company reported the following as plant assets.
Land
$ 2,000,000
Buildings
$20,000,000
Less: Accumulated depreciation—buildings
8,000,000
12,000,000
Equipment
30,000,000
Less: Accumulated depreciation—equipment
$20,000,000
26,000,000
Total plant assets
$40,000,000
During 2012, the following selected cash transactions occurred.
April 1 Purchased land for $1,200,000.
May 1 Sold equipment that cost $420,000 when purchased on January 1, 2008.The equipment was sold for $240,000.
June 1 Sold land purchased on June 1, 2002, for $1,000,000.The land cost $340,000.
July 1 Purchased equipment for $1,100,000.
Dec. 31 Retired equipment that cost $300,000 when purchased on December 31, 2002. No salvage value was received.
Instructions
(a) Journalize the above transactions. Starkey uses straight line depreciation for buildings and equipment. The buildings are estimated to have a 50 year useful life and no salvage value. The equipment is estimated to have a 10 year useful life and no salvage value. Update depreciation on assets disposed of at the time of sale or retirement.
(b) Record adjusting entries for depreciation for 2012.
(c) Prepare the plant assets section of Starkey’s balance sheet at December 31, 2012.
The intangible assets section of Time Company at December 31, 2011, is presented below.
Patent ($100,000 cost less $10,000 amortization)
$ 90,000
Copyright ($60,000 cost less $24,000 amortization)
36,000
Total
$126,000
The patent was acquired in January 2011 and has a useful life of 10 years .The copyright was acquired in January 2008 and also has a useful life of 10 years .The following cash transactions may have affected intangible assets during 2012.
Jan. 2 Paid $45,000 legal costs to successfully defend the patent against infringement by another company.
Jan.–June Developed a new product, incurring $230,000 in research and development costs .A patent was granted for the product on July 1. Its useful life is equal to its legal life.
Sept. 1 Paid $125,000 to an X games star to appear in commercials advertising the company’s products. The commercials will air in September and October.
Oct. 1 Acquired a copyright for $200,000.The copyright has a useful life of 50 years.
Instructions
(a) Prepare journal entries to record the transactions above.
(b) Prepare journal entries to record the 2012 amortization expense for intangible assets.
(c) Prepare the intangible assets section of the balance sheet at December 31, 2012.
(d) Prepare the note to the financials on Time’s intangibles as of December 31, 2012.
Due to rapid turnover in the accounting department, a number of transactions involving intangible assets were improperly recorded by Wasp Company in 2011.
1. Wasp developed a new manufacturing process, incurring research and development costs of $110,000.The company also purchased a patent for $50,000. In early January ,Wasp capitalized $160,000 as the cost of the patents. Patent amortization expense of $8,000 was recorded based on a 20 year useful life.
2. On July 1, 2011, Wasp purchased a small company and as a result acquired goodwill of $200,000.Wasp recorded a half year’s amortization in 2011, based on a 50 year life ($2,000 amortization).The goodwill has an indefinite life.
Instructions
Prepare all journal entries necessary to correct any errors made during 2011. Assume the books have not yet been closed for 2011.
McLead Corporation and Gene Corporation, two corporations of roughly the same size, are both involved in the manufacture of canoes and sea kayaks. Each company depreciates its plant assets using the straight line approach.An investigation of their financial statements
reveals the following information.
McLead Corp.
Gene Corp.
Net income
$ 300,000
$ 325,000
Sales
1,100,000
990,000
Average total assets
1,000,000
1,050,000
Average plant assets
750,000
770,000
Instructions
(a) For each company, calculate the asset turnover ratio.
(b) Based on your calculations in part (a), comment on the relative effectiveness of the two companies in using their assets to generate sales and produce net income.
Pinkerton Corporation’s trial balance at December 31, 2011, is presented below. All 2011 transactions have been recorded except for the items described after the trial balance.
Debit
Credit
Cash
$28,000
Accounts Receivable
36,800
Notes Receivable
10,000
Interest Receivable
–0–
Merchandise Inventory
36,200
Prepaid Insurance
3,600
Land
20,000
Building
150,000
Equipment
60,000
Patent
9,000
Allowance for Doubtful Accounts
$500
Accumulated Depreciation—
50,000
Accumulated Depreciation—
24,000
Accounts Payable
27,300
Salaries Payable
–0–
Unearned Rent
6,000
Notes Payable (short term)
11,000
Interest Payable
–0–
Notes Payable (long term)
35,000
Common Stock
50,000
Retained Earnings
63,600
Dividends
12,000
Sales
900,000
Interest Revenue
–0–
Rent Revenue
–0–
Gain on Disposal
–0–
Bad Debts Expense
–0–
Cost of Goods Sold
630,000
Depreciation Expense—Buildings
–0–
Depreciation Expense—Equipment
–0–
Insurance Expense
–0–
Interest Expense
–0–
Other Operating Expenses
61,800
Amortization Expense—Patents
–0–
Salaries Expense
110,000
Total
$1,167,400
$1,167,400
Unrecorded transactions
1. On May 1, 2011, Pinkerton purchased equipment for $16,000 plus sales taxes of $800 (all paid in cash).
2. On July 1, 2011, Pinkerton sold for $3,500 equipment which originally cost $5,000. Accumulated depreciation on this equipment at January 1, 2011, was $1,800; 2011 depreciation prior to the sale of equipment was $450.
3. On December 31, 2011, Pinkerton sold for $5,000 on account inventory that cost $3,500.
4. Pinkerton estimates that uncollectible accounts receivable at year end are $4,000.
5. The note receivable is a one year, 8% note dated April 1, 2011. No interest has been recorded.
6. The balance in prepaid insurance represents payment of a $3,600, 6 month premium on September 1, 2011.
7. The building is being depreciated using the straight line method over 30 years. The salvage value is $30,000.
8. The equipment owned prior to this year is being depreciated using the straight line method over 5 years.
The salvage value is 10% of cost.
9. The equipment purchased on May 1, 2011, is being depreciated using the straight line method over 5 years, with a salvage value of $1,800.
10. The patent was acquired on January 1, 2011, and has a useful life of 9 years from that date.
11. Unpaid salaries at December 31, 2011, total $2,200.
12. The unearned rent of $6,000 was received on December 1, 2011, for 3 months’ rent.
13. Both the short term and long term notes payable are dated January 1, 2011, and carry a 10% interest rate. All interest is payable in the next 12 months.
14. Income tax expense was $15,000. It was unpaid at December 31.
Instructions
(a) Prepare journal entries for the transactions listed above.
(b) Prepare an updated December 31, 2011, trial balance.
(c) Prepare a 2011 income statement and a 2011 retained earnings statement.
Reimer Company and Lingo Company are two proprietorships that are similar in many respects. One difference is that Reimer Company uses the straight line method and Lingo Company uses the declining balance method at double the straight line rate. On January 2, 2009, both companies acquired the following depreciable assets.
Asset
Cost
Salvage Value
Useful Life
Building
$320,000
$20,000
40 years
Equipment
110,000
10,000
10 years
Including the appropriate depreciation charges, annual net income for the companies in the years 2009, 2010, and 2011 and total income for the 3 years were as follows.
2009
2010
2011
Total
Reimer Company
$84,000
$88,400
$90,000
$262,400
Lingo Company
68,000
76,000
85,000
229,000
At December 31, 2011, the balance sheets of the two companies are similar except that Lingo Company has more cash than Reimer Company. Sally Vogts is interested in buying one of the companies. She comes to you for advice.
Instructions
With the class divided into groups, answer the following.
(a)Determine the annual and total depreciation recorded by each company during the 3 years.
(b) Assuming that Lingo Company also uses the straight line method of depreciation instead of the declining balance method as in (a), prepare comparative income data for the 3 years.
Both the “All About You” story and the Feature Story at the beginning of the chapter discussed the company Rent A Wreck. Note that the trade name Rent A Wreck is a very important asset to the company, as it creates immediate product identification. As indicated in the chapter, companies invest substantial sums to ensure that their product is well known to the consumer. Test your knowledge of who owns some famous brands and their impact on the financial statements.
Instructions
(a) Provide an answer to the five multiple choice questions below.
(1) Which company owns both Taco Bell and Pizza Hut?
(a) McDonald’s.
(b) CKE.
(c) Yum Brands.
(d) Wendy’s.
(2) Dairy Queen belongs to:
(a) Breyer.
(b) Berkshire Hathaway.
(c) GE.
(d) The Coca Cola Company.
(3) Phillip Morris, the cigarette maker, is owned by:
(a) Altria.
(b) GE.
(c) Boeing.
(d) ExxonMobil.
(4) AOL, a major Internet provider, belongs to:
(a) Microsoft.
(b) Cisco.
(c) NBC.
(d) Time Warner.
(5) ESPN, the sports broadcasting network, is owned by:
(a) Procter & Gamble.
(b) Altria.
(c) Walt Disney.
(d) The Coca Cola Company.
(b) How do you think the value of these brands is reported on the appropriate company’s balance sheet?
Snyder Software Inc. has successfully developed a new spreadsheet program. To produce and market the program, the company needed $2 million of additional financing. On January 1, 2012, Snyder borrowed money as follows.
1. Snyder issued $500,000, 11%, 10 year convertible bonds.The bonds sold at face value and pay semiannual interest on January 1 and July 1. Each $1,000 bond is convertible into 30 shares of Snyder’s $20 par value common stock.
2. Snyder issued $1 million, 10%, 10 year bonds at face value. Interest is payable semiannually on January 1 and July 1.
3. Snyder also issued a $500,000, 12%, 15 year mortgage note payable. The terms provide for semiannual installment payments of $36,324 on June 30 and December 31.
Instructions
1. For the convertible bonds, prepare journal entries for:
(a) The issuance of the bonds on January 1, 2012.
(b) Interest expense on July 1 and December 31, 2012.
(c) The payment of interest on January 1, 2013.
(d) The conversion of all bonds into common stock on January 1, 2013, when the market value of the common stock was $67 per share.
2. For the 10 year, 10% bonds:
(a) Journalize the issuance of the bonds on January 1, 2012.
(b) Prepare the journal entries for interest expense in 2012. Assume no accrual of interest on July 1.
(c) Prepare the entry for the redemption of the bonds at 101 on January 1, 2015, after paying the interest due on this date.
3. For the mortgage note payable:
(a) Prepare the entry for the issuance of the note on January 1, 2012.
(b) Prepare a payment schedule for the first four installment payments.
(c) Indicate the current and noncurrent amounts for the mortgage note payable at December 31, 2012.
On January 1, Dias Corporation issued $1,000,000, 14%, 5 year bonds with interest payable on July 1 and January 1. The bonds sold for $1,098,540.The market rate of interest for these bonds was 12%. On the first interest date, using the effective interest method, the debit entry to Bond Interest Expense is for:
a. $60,000.
b. $76,898.
c. $65,912.
d. $131,825.
On January 1, Dias Corporation issued $1,000,000, 14%, 5 year bonds with interest payable on July 1 and January 1. The bonds sold for $1,098,540.The market rate of interest for these bonds was 12%. On the first interest date, using the effective interest method, the debit entry to Bond Interest Expense is for:
Lorena Furniture Company manufactures living room furniture through two departments: Framing and Upholstering. Materials are entered at the beginning of each process. For May, the following cost data are obtained from the two work in process accounts.
Framing
Upholstering
Work in process, May 1
$ –0–
$ ?
Materials
420,000
?
Conversion costs
280,000
330,000
Costs transferred in
–0–
600,000
Costs transferred out
600,000
?
Work in process, May 31
100,000
?
Instructions
Answer the following questions.
(a) If 3,000 sofas were started into production on May 1 and 2,500 sofas were transferred to Upholstering, what was the unit cost of materials for May in the Framing Department?
(b) Using the data in (a) above, what was the per unit conversion cost of the sofas transferred to Upholstering?
(c) Continuing the assumptions in (a) above, what is the percentage of completion of the units in process at May 31 in the Framing Department?
Meg Ryan was a good friend of yours in high school and is from your home town. While you chose to major in accounting when you both went away to college, she majored in marketing and management. You have recently been promoted to accounting manager for the Snack Foods Division of Tranh Enterprises, and your friend was promoted to regional sales manager for the same division of Tranh. Meg recently telephoned you. She explained that she was familiar with job cost sheets, which had been used by the Special Projects division where she had formerly worked. She was, however, very uncomfortable with the production cost reports prepared by your division. She emailed you a list of her particular questions:
1. Since Tranh occasionally prepares snack foods for special orders in the Snack Foods Division, why don’t we track costs of the orders separately?
2. What is an equivalent unit?
3. Why am I getting four production cost reports? Isn’t there one Work in Process account?
Instructions
Prepare a memo to Meg. Answer her questions, and include any additional information you think would be helpful. You may write informally, but do use proper grammar and punctuation.
In recent years, Pablo Company purchased three machines. Because of heavy turnover in the accounting department, a different accountant was in charge of selecting the depreciation method for each machine, and each selected a different method. Information concerning the machines is summarized below.
Salvage
Useful Life
Depreciation
Machine
Acquired
Cost
Value
in Years
Method
1
1/1/09
$105,000
$ 5,000
10
Straight line
2
1/1/09
150,000
10,000
8
Declining balance
3
11/1/11
100,000
15,000
6
Units of activity
For the declining balance method, the company uses the double declining rate. For the units of activity method, total machine hours are expected to be 25,000. Actual hours of use in the first 3 years were: 2011, 2,000; 2012, 4,500; and 2013, 5,500.
Instructions
(a) Compute the amount of accumulated depreciation on each machine at December 31, 2011.
(b) If machine 2 had been purchased on May 1 instead of January 1, what would be the depreciation expense for this machine in (1) 2009 and (2) 2010?
On January 1, 2011, Arlo Company purchased the following two machines for use in its production process. Machine A: The cash price of this machine was $55,000. Related expenditures included: salestax $2,750, shipping costs $100, insurance during shipping $75, installation and testing costs $75, and $90 of oil and lubricants to be used with the machinery during its first year of operation.Arlo estimates that the useful life of the machine is 4 years with a $5,000 salvage value remaining at the end of that time period. Machine B: The recorded cost of this machine was $100,000. Arlo estimates that the useful life of the machine is 4 years with a $10,000 salvage value remaining at the end of that time period.
Instructions
(a) Prepare the following for machine A.
(1) The journal entry to record its purchase on January 1, 2011.
(2) The journal entry to record annual depreciation at December 31, 2011, assuming the straight line method of depreciation is used.
(b) Calculate the amount of depreciation expense that Arlo should record for machine B each year of its useful life under the following assumption.
(1) Arlo uses the straight line method of depreciation.
(2) Arlo uses the declining balance method.The rate used is twice the straight line rate.
(3) Arlo uses the units of activity method and estimates the useful life of the machine is 25,000 units. Actual usage is as follows: 2011, 5,500 units; 2012, 7,000 units; 2013, 8,000 units; 2014, 4,500 units.
(c) Which method used to calculate depreciation on machine B reports the lowest amount of depreciation expense in year 1 (2011)? The lowest amount in year 4 (2014)? The lowest total amount over the 4 year period?
The Polishing Department of Burgoa Manufacturing Company has the following production and manufacturing cost data for September. Materials are entered at the beginning of the process.
Production: Beginning inventory 1,600 units that are 100% complete as to materials and 30% complete as to conversion costs; units started during the period are 18,400; ending inventory of 5,000 units 10% complete as to conversion costs.
Manufacturing costs: Beginning inventory costs, comprised of $20,000 of materials and $43,180 of conversion costs; materials costs added in Polishing during the month, $177,200; labor and overhead applied in Polishing during the month, $102,680 and $257,140, respectively.
Instructions
(a) Compute the equivalent units of production for materials and conversion costs for the month of September.
(b) Compute the unit costs for materials and conversion costs for the month.
(c) Determine the costs to be assigned to the units transferred out and in process.
The Welding Department of Castro Manufacturing Company has the following production and manufacturing cost data for February 2012. All materials are added at the beginning of the process.
Manufacturing Costs
Production Data
Beginning work in process
Beginning work in process
15,000 units
Materials
$18,000
1/10 complete
Conversion costs
14,175
$32,175
Units transferred out
49,000
Materials
180,000
Units started
60,000
Labor
32,780
Ending work in process
26,000 units
Overhead
61,445
1/5 complete
Instructions
Prepare a production cost report for the Welding Department for the month of February.
Debrozzo Shipping, Inc. is contemplating the use of process costing to track the costs of its operations. The operation consists of three segments (departments): receiving, shipping, and delivery. Containers are received at Debrozzo’s docks and sorted according to the ship they will be carried on. The containers are loaded onto a ship, which carries them to the appropriate port of destination. The containers are then off loaded and delivered to the receiving company.
Debrozzo Shipping wants to begin using process costing in the shipping department. Direct materials represent the fuel costs to run the ship, and “Containers in transit” represents work in process. Listed below is information about the shipping department’s first month’s activity.
Containers in transit, April 1
0
Containers loaded
800
Containers in transit, April 30
350
40% of direct materials and
30% of conversion costs
Instructions
(a) Determine the physical flow of containers for the month.
(b) Calculate the equivalent units for direct materials and conversion costs.
Imelda Instrument Inc. manufactures two products: missile range instruments and space pressure gauges. During January, 50 range instruments and 300 pressure gauges were produced, and overhead costs of $81,000 were incurred. An analysis of overhead costs reveals the following activities.
Activity
Cost Driver
Total Cost
1. Materials handling
Number of requisitions
$30,000
2. Machine setups
Number of setups
27,000
3. Quality inspections
Number of inspections
24,000
The cost driver volume for each product was as follows.
Cost Driver
Instruments
Gauges
Total
Number of requisitions
400
600
1,000
Number of setups
150
300
450
Number of inspections
200
400
600
Instructions
(a) Determine the overhead rate for each activity.
(b) Assign the manufacturing overhead costs for January to the two products using activity based costing.
(c) Write a memo to the president of Imelda Instrument, explaining the benefits of activity based costing.
Mathias Company manufactures a number of specialized machine parts. Part B unkka 22 uses $35 of direct materials and $15 of direct labor per unit. Mathias’ estimated manufacturing overhead is as follows:
Materials handling
$100,000
Machining
200,000
Factory supervision
150,000
Total
$450,000
Overhead is applied based on direct labor costs, which were estimated at $200,000. Mathias is considering adopting activity based costing. The cost drivers are estimated at:
Activity
Cost Driver
Expected Use
Materials handling
Weight of materials
50,000 pounds
Machining
Machine hours
20,000 hours
Factory supervision
Direct labor hours
12,000 hours
Instructions
(a) Compute the cost of 1,000 units of Bunkka 22 using the current traditional costing system.
(b) Compute the cost of 1,000 units of Bunkka 22 using the proposed activity based costing system.
Assume the 1,000 units use 2,500 pounds of materials, 500 machine hours, and 1,000 direct labor hours.
Zou Company manufactures bowling balls through two processes: Molding and Packaging. In the Molding Department, the urethane, rubber, plastics, and other materials are molded into bowling balls. In the Packaging Department, the balls are placed in cartons and sent to the finished goods warehouse. All materials are entered at the beginning of each process. Labor and manufacturing overhead are incurred uniformly throughout each process. Production and cost data for the Molding Department during June 2012 are presented below.
Production Data
June
Beginning work in process units
–0–
Units started into production
20,000
Ending work in process units
2,000
Percent complete—ending inventory
60%
Cost Data
Materials
$198,000
Labor
50,400
Overhead
112,800
Total
$361,200
Instructions
(a) Prepare a schedule showing physical units of production.
(b) Determine the equivalent units of production for materials and conversion costs.
(c) Compute the unit costs of production.
(d) Determine the costs to be assigned to the units transferred and in process for June.
(e) Prepare a production cost report for the Molding Department for the month of June.
Chakos Industries Inc. manufactures in separate processes furniture for homes. In each process, materials are entered at the beginning, and conversion costs are incurred uniformly. Production and cost data for the first process in making two products in two different manufacturing plants are as follows.
Cutting Department
Plant 1
Plant 2
Production Data—July
T12 Tables
C10 Chairs
Work in process units, July 1
–0–
–0–
Units started into production
20,000
16,000
Work in process units, July 31
3,000
500
Work in process percent complete
60
80
Cost Data—July
Work in process, July 1
$ –0–
$ –0–
Materials
380,000
288,000
Labor
234,400
125,900
Overhead
104,000
96,700
Total
$718,400
$510,600
Instructions
(a) For each plant:
(1) Compute the physical units of production.
(2) Compute equivalent units of production for materials and for conversion costs.
(3) Determine the unit costs of production.
(4) Show the assignment of costs to units transferred out and in process.
(b) Prepare the production cost report for Plant 1 for July 2012.
Dees Company manufactures its product, Vitadrink, through two manufacturing processes: Mixing and Packaging. All materials are entered at the beginning of each process. On October 1, 2012, inventories consisted of Raw Materials $26,000, Work in Process—Mixing $0, Work in Process—Packaging $250,000, and Finished Goods $289,000. The beginning inventory for Packaging consisted of 10,000 units that were 50% complete as to conversion costs and fully complete as to materials. During October, 50,000 units were started into production in the Mixing Department and the following transactions were completed.
1. Purchased $300,000 of raw materials on account.
2. Issued raw materials for production: Mixing $210,000 and Packaging $45,000.
3. Incurred labor costs of $248,900.
4. Used factory labor: Mixing $182,500 and Packaging $66,400.
5. Incurred $790,000 of manufacturing overhead on account.
6. Applied manufacturing overhead on the basis of $22 per machine hour. Machine hours were 28,000 in Mixing and 6,000 in Packaging.
7. Transferred 45,000 units from Mixing to Packaging at a cost of $979,000.
8. Transferred 53,000 units from Packaging to Finished Goods at a cost of $1,315,000.
9. Sold goods costing $1,604,000 for $2,500,000 on account.
Fong Company manufactures basketballs. Materials are added at the beginning of the production process and conversion costs are incurred uniformly. Production and cost data for the month of July 2012 are as follows.
Production Data—Basketballs
Units
Percent Complete
Work in process units, July 1
500
60%
Units started into production
1,000
Work in process units, July 31
600
30%
Cost Data—Basketballs
Work in process, July 1
Materials
$750
Conversion costs
600
$1,350
Direct materials
2,400
Direct labor
1,580
Manufacturing overhead
1,060
Instructions
(a) Calculate the following.
(1) The equivalent units of production for materials and conversion.
(2) The unit costs of production for materials and conversion costs.
(3) The assignment of costs to units transferred out and in process at the end of the accounting period.
(b) Prepare a production cost report for the month of July for the basketballs.
Martine Processing Company uses a weighted average process costing system and manufactures a single product—a premium rug shampoo and cleaner. The manufacturing activity for the month of October has just been completed. A partially completed production cost report for the month of October for the mixing and cooking department is shown below.
Instructions
(a) Prepare a schedule that shows how the equivalent units were computed so that you can complete the “Quantities: Units accounted for” equivalent units section shown in the production cost report, and compute October unit costs.
(b) Complete the “Cost Reconciliation Schedule” part of the production cost report below.
Gerber Electronics manufactures two large screen television models: the Royale, which sells for $1,500, and a new model, the Majestic, which sells for $1,200. The production cost per unit for each model in 2012 is shown on the page.
Royale
Majestic
Direct materials
$ 700
$420
Direct labor ($20 per hour)
100
80
Manufacturing overhead ($40 per DLH)
200
160
Total per unit cost
$1,000
$660
In 2012, Gerber manufactured 30,000 units of the Royale and 10,000 units of the Majestic. The overhead rate of $40 per direct labor hour was determined by dividing total expected manufacturing overhead of $7,600,000 by the total direct labor hours (190,000) for the two models. The gross profit on the model was: Royale $500 ($1,500 $1,000) and Majestic $540 ($1,200 $660). Because of this difference, management is considering phasing out the Royale model and increasing the production of the Majestic model.
Before finalizing its decision, management asks the controller, Sally Fields, to prepare an analysis using activity based costing. Sally accumulates the following information about overhead for the year ended December 31, 2012.
Cost
Total
Driver
Overhead
Activity
Cost Driver
Cost
Volume
Rate
Purchase orders
Number of orders
$1,200,000
30,000
$40
Machine setups
Number of setups
900,000
15,000
60
Machining
Machine hours
4,800,000
160,000
30
Quality control
Number of inspections
700,000
35,000
20
The cost driver volume for each product was:
Cost Driver
Royale
Majestic
Total
Purchase orders
16,000
14,000
30,000
Machine setups
5,000
10,000
15,000
Machine hours
100,000
60,000
160,000
Inspections
10,000
25,000
35,000
Instructions
(a) Assign the total 2012 manufacturing overhead costs to the two products using activity based costing (ABC).
(b) What was the cost per unit and gross profit of each model using ABC costing?
(c) Are management’s future plans for the two models sound?
Rivers Corporation manufactures water skis through two processes: Molding and Packaging. In the Molding Department, fiberglass is heated and shaped into the form of a ski. In the Packaging Department, the skis are placed in cartons and sent to the finished goods warehouse. Materials are entered at the beginning of both processes. Labor and manufacturing overhead are incurred uniformly throughout each process. Production and cost data for the Molding Department for January 2012 are presented below.
Production Data
January
Beginning work in process units
–0–
Units started into production
42,500
Ending work in process units
2,500
Percent complete—ending inventory
40%
Cost Data
Materials
$510,000
Labor
96,000
Overhead
150,000
Total
$756,000
Instructions
(a) Compute the physical units of production.
(b) Determine the equivalent units of production for materials and conversion costs.
(c) Compute the unit costs of production.
(d) Determine the costs to be assigned to the units transferred out and in process.
(e) Prepare a production cost report for the Molding Department for the month of January.
Klein Corporation manufactures in separate processes refrigerators and freezers for homes. In each process, materials are entered at the beginning and conversion costs are incurred uniformly. Production and cost data for the first process in making two products in two different manufacturing plants are as follows.
Stamping Department
Plant A
Plant B
Production Data—June
R12 Refrigerators
F24 Freezers
Work in process units, June 1
–0–
–0–
Units started into production
21,000
20,000
Work in process units, June 30
4,000
2,500
Work in process percent complete
75
60
Cost Data—June
Work in process, June 1
$ –0–
$ –0–
Materials
840,000
720,000
Labor
220,000
221,000
Overhead
420,000
292,000
Total
$1,480,000
$1,233,000
Instructions
(a) For each plant:
(1) Compute the physical units of production.
(2) Compute equivalent units of production for materials and for conversion costs.
(3) Determine the unit costs of production.
(4) Show the assignment of costs to units transferred out and in process.
(b) Prepare the production cost report for Plant A for June 2012.
Forrest Company manufactures a nutrient, Everlife, through two manufacturing processes: Blending and Packaging. All materials are entered at the beginning of each process. On August 1, 2012, inventories consisted of Raw Materials $5,000, Work in Process—Blending $0, Work in Process—Packaging $3,945, and Finished Goods $7,500. The beginning inventory for Packaging consisted of 500 units, two fifths complete as to conversion costs and fully complete as to materials. During August, 9,000 units were started into production in Blending, and the following transactions were completed.
1. Purchased $25,000 of raw materials on account.
2. Issued raw materials for production: Blending $18,930 and Packaging $9,140.
3. Incurred labor costs of $23,770.
4. Used factory labor: Blending $13,320 and Packaging $10,450.
5. Incurred $41,500 of manufacturing overhead on account.
6. Applied manufacturing overhead at the rate of $25 per machine hour. Machine hours were Blending 900 and Packaging 300.
7. Transferred 8,200 units from Blending to Packaging at a cost of $44,940.
8. Transferred 8,600 units from Packaging to Finished Goods at a cost of $67,490.
9. Sold goods costing $62,000 for $90,000 on account.
Ignatenko Company has several processing departments. Costs charged to the Assembly Department for October 2012 totaled $1,249,500 as follows.
Work in process, October 1
Materials
$29,000
Conversion costs
16,500
$ 45,500
Materials added
1,006,000
Labor
90,000
Overhead
108,000
Production records show that 25,000 units were in beginning work in process 40% complete as to conversion cost, 425,000 units were started into production, and 35,000 units were in ending work in process 40% complete as to conversion costs. Materials are entered at the beginning of each process.
Instructions
(a) Determine the equivalent units of production and the unit production costs for the Assembly Department.
(b) Determine the assignment of costs to goods transferred out and in process.
(c) Prepare a production cost report for the Assembly Department.
Forte Company manufactures bicycles and tricycles. For both products, materials are added at the beginning of the production process, and conversion costs are incurred uniformly. Production and cost data for the month of May are as follows.
Production Data—Bicycles
Units
Percent Complete
Work in process units, May 1
500
80%
Units started in production
1,500
Work in process units, May 31
800
25%
Cost Data—Bicycles
Work in process, May 1
Materials
$15,000
Conversion costs
18,000
$33,000
Direct materials
50,000
Direct labor
18,320
Manufacturing overhead
33,680
Instructions
(a) Calculate the following.
(1) The equivalent units of production for materials and conversion.
(2) The unit costs of production for materials and conversion costs.
(3) The assignment of costs to units transferred out and in process at the end of the accounting period.
(b) Prepare a production cost report for the month of May for the bicycles.
Thang Cleaner Company uses a weighted average process costing system and manufactures a single product—an all purpose liquid cleaner. The manufacturing activity for the month of March has just been completed. A partially completed production cost report for the month of March for the mixing and blending department is shown below.
THANG CLEANER COMPANY
Mixing and Blending Department
Production Cost Report
For the Month Ended March 31
Equivalent Units
Physical
Conversion
QUANTITIES
Units
Materials
Costs
Units to be accounted for
Work in process, March 1
10,000
Started into production
100,000
Total units
110,000
Units accounted for
Transferred out
95,000
?
?
Work in process, March 31
(60% materials, 20%
conversion costs)
15,000
?
?
Total units
110,000
?
?
COSTS
Conversion
Unit costs
Materials
Costs
Total
Costs in March
$156,000
$ 98,000
$254,000
Equivalent units
?
?
Unit costs
$ ?
+ $ ?
= $ ?
Costs to be accounted for
Work in process, March 1
$ 8,700
Started into production
245,300
Total costs
$254,000
COST RECONCILIATION SCHEDULE
Costs accounted for
Transferred out
$ ?
Work in process, March 31
Materials
?
Conversion costs
?
?
Total costs
?
Instructions
(a) Prepare a schedule that shows how the equivalent units were computed so that you can complete the “Quantities: Units accounted for” equivalent units section shown in the production cost report above, and compute March unit costs.
(b) Complete the “Cost Reconciliation Schedule” part of the production cost report above.
Sea Breeze Beach Company manufactures suntan lotion, called Surtan, in 11 ounce plastic bottles. Surtan is sold in a competitive market. As a result, management is very cost conscious. Surtan is manufactured through two processes: mixing and filling. Materials are entered at the beginning of each process and labor and manufacturing overhead occur uniformly throughout each process. Unit costs are based on the cost per gallon of Surtan using the weighted average costing approach.
On June 30, 2012, Rita Jenz, the chief accountant for the past 20 years, opted to take early retirement. Her replacement, Neil Benton, had extensive accounting experience with motels in the area but only limited contact with manufacturing accounting. During July, Neil correctly accumulated the following production quantity and cost data for the Mixing Department.
Production quantities: Work in process, July 1, 8,000 gallons 75% complete; started into production 91,000 gallons; work in process, July 31, 5,000 gallons 20% complete. Materials are added at the beginning of the process.
Production costs: Beginning work in process $88,000, comprised of $21,000 of materials costs and $67,000 of conversion costs; incurred in July: materials $573,000, conversion costs $769,000.
Neil then prepared a production cost report on the basis of physical units started into production. His report showed a production cost of $15.71 per gallon of Surtan. The management of Sea Breeze Beach was surprised at the high unit cost. The president comes to you, as Rita’s top assistant, to review Neil’s report and prepare a correct report if necessary.
Instructions
With the class divided into groups, answer the following questions.
(a) Show how Neil arrived at the unit cost of $15.71 per gallon of Surtan.
(b) What error(s) did Neil make in preparing his production cost report?
(c) Prepare a correct production cost report for July.
Hutto Company manufactures CH 21 through two processes: Mixing and Packaging. In July, the following costs were incurred.
Mixing
Packaging
Raw Materials used
$10,000
$24,000
Factory Labor costs
8,000
36,000
Manufacturing Overhead costs
12,000
54,000
Units completed at a cost of $21,000 in the Mixing Department are transferred to the Packaging Department. Units completed at a cost of $102,000 in the Packaging Department are transferred to Finished Goods. Journalize the assignment of these costs to the two processes and the transfer of units as appropriate.
In the course of routine checking of all journal entries prior to preparing year end reports, Maria Ferreira discovered several strange entries. She recalled that the president’s son Tom had come in to help out during an especially busy time and that he had recorded some journal entries. She was relieved that there were only a few of his entries, and even more relieved that he had included rather lengthy explanations. The entries Tom made were:
(1)
Work in Process Inventory
25,000
Cash
25,000
(This is for materials put into process. I didn’t find the record that we paid for these, so I’m crediting Cash, because I know we’ll have to pay for them sooner or later.)
(2)
Manufacturing Overhead
12,000
Cash
12,000
(This is for bonuses paid to salespeople. I know they’re part of overhead, and I can’t find an account called “Non factory Overhead” or “Other Overhead” so I’m putting it in Manufacturing Overhead. I have the check stubs, so I know we paid these.)
(3)
Wages Expense
120,000
Cash
120,000
(This is for the factory workers’ wages. I have a note that payroll taxes are $15,000. I still think that’s part of wages expense, and that we’ll have to pay it all in cash sooner or later, so I credited Cash for the wages and the taxes.)
(4)
Work in Process Inventory
3,000
Raw Materials Inventory
3,000
This is for the glue used in the factory. I know we used this to make the products, even though we didn’t use very much on any one of the products. I got it out of inventory, so I credited an inventory account.)
Instructions
(a) How should Tom have recorded each of the four events?
(b) If the entry was not corrected, which financial statements (income statement or balance sheet) would be affected? What balances would be overstated or understated?
Irma’s Interiors uses a job order costing system to collect the costs of its interior decorating business. Each client’s consultation is treated as a separate job. Overhead is applied to each job based on the number of decorator hours incurred. Listed below are data for the current year.
Budgeted overhead
$960,000
Actual overhead
$982,800
Budgeted decorator hours
40,000
Actual decorator hours
40,500
The company uses Operating Overhead in place of Manufacturing Overhead.
Instructions
(a) Compute the predetermined overhead rate.
(b) Prepare the entry to apply the overhead for the year.
(c) Determine whether the overhead was under or overapplied and by how much.
Lyon Manufacturing uses a job order cost system in each of its three manufacturing departments. Manufacturing overhead is applied to jobs on the basis of direct labor cost in Department F, direct labor hours in Department G, and machine hours in Department H. In establishing the predetermined overhead rates for 2012, the following estimates were made for the year.
Department
F
G
H
Manufacturing overhead
$780,000
$640,000
$750,000
Direct labor cost
$600,000
$100,000
$600,000
Direct labor hours
50,000
40,000
40,000
Machine hours
100,000
120,000
150,000
During January, the job cost sheets showed the following costs and production data.
Department
F
G
H
Direct materials used
$92,000
$86,000
$64,000
Direct labor cost
$48,000
$35,000
$50,400
Manufacturing overhead incurred
$66,000
$60,000
$62,100
Direct labor hours
4,000
3,500
4,200
Machine hours
8,000
10,500
12,600
Instructions
(a) Compute the predetermined overhead rate for each department.
(b) Compute the total manufacturing costs assigned to jobs in January in each department.
(c) Compute the under or overapplied overhead for each department at January 31.
Manufacturing cost data for Meneses Company, which uses a job order cost system, are presented below.
Case A
Case B
Case C
Direct materials used
$ (a)
$ 83,000
$ 63,150
Direct labor
50,000
120,000
(h)
Manufacturing overhead applied
42,500
(d)
(i)
Total manufacturing costs
155,650
(e)
213,000
Work in process 1/1/12
(b)
15,500
18,000
Total cost of work in process
201,500
(f)
(j)
Work in process 12/31/12
(c)
11,800
(k)
Cost of goods manufactured
192,300
(g)
222,000
Instructions
Indicate the missing amount for each letter. Assume that in all cases manufacturing overhead is applied on the basis of direct labor cost and the rate is the same.
Nami Yee is a contractor specializing in custom built jacuzzis. On May 1, 2012, her ledger contains the following data.
Raw Materials Inventory
$30,000
Work in Process Inventory
12,200
Manufacturing Overhead
2,500 (dr.)
The Manufacturing Overhead account has debit totals of $12,50 and credit totals of $10,000. Subsidiary data for Work in Process Inventory on May 1 include:
Job Cost Sheets
Job
Manufacturing
by Customer
Direct Materials
Direct Labor
Overhead
Scott
$2,500
$2,000
$1,400
Condon
2,000
1,200
840
Keefe
900
800
560
$5,400
$4,000
$2,800
During May, the following costs were incurred: (a) raw materials purchased on account $4,000, (b) labor paid $7,600, and (c) manufacturing overhead paid $1,400. A summary of materials requisition slips and time tickets for the month of May reveals the following.
Job by Customer
Materials Requisition Slips
Time Tickets
Scott
$ 500
$ 400
Condon
600
1,000
Keefe
2,300
1,300
Tarr
1,900
2,900
5,300
5,600
General use
1,500
2,000
$6,800
$7,600
Overhead was charged to jobs on the basis of $0.70 per dollar of direct labor cost.
The jacuzzis for customers Scott, Condon, and Keefe were completed during May. Each jacuzzi was sold for $12,000 cash.
Instructions
(a) Prepare journal entries for the May transactions: (i) for purchase of raw materials, factory labor costs incurred, and manufacturing overhead costs incurred; (ii) assignment of raw materials, labor, and overhead to production; and (iii) completion of jobs and sale of goods.
(b) Post the entries to Work in Process Inventory.
(c) Reconcile the balance in Work in Process Inventory with the costs of unfinished jobs.
(d) Prepare a cost of goods manufactured schedule for May.
Saeed Manufacturing uses a job order cost system and applies overhead to production on the basis of direct labor hours. On January 1, 2012, Job No. 25 was the only job in process. The costs incurred prior to January 1 on this job were as follows: direct materials $10,000; direct labor $6,000; and manufacturing overhead $9,000. Job No. 23 had been completed at a cost of $42,000 and was part of finished goods inventory. There was a $5,000 balance in the Raw Materials Inventory account.
During the month of January, the company began production on Jobs 26 and 27, and completed Jobs 25 and 26. Jobs 23 and 25 were sold on account during the month for $63,000 and $74,000, respectively. The following additional events occurred during the month.
1. Purchased additional raw materials of $40,000 on account.
2. Incurred factory labor costs of $31,500. Of this amount, $7,500 related to employer payroll taxes.
3. Incurred manufacturing overhead costs as follows: indirect materials $10,000; indirect labor $7,500; depreciation expense on equipment $12,000; and various other manufacturing overhead costs on account $11,000.
4. Assigned direct materials and direct labor to jobs as follows.
Job No.
Direct Materials
Direct Labor
25
$ 5,000
$ 3,000
26
17,000
12,000
27
13,000
9,000
5. The company uses direct labor hours as the activity base to assign overhead. Direct labor hours incurred on each job were as follows: Job No. 25, 200; Job No. 26, 800; and Job No. 27, 600.
Instructions
(a) Calculate the predetermined overhead rate for the year 2012, assuming Saeed Manufacturing estimates total manufacturing overhead costs of $480,000, direct labor costs of $300,000, and direct labor hours of 20,000 for the year.
(b) Open job cost sheets for Jobs 25, 26, and 27. Enter the January 1 balances on the job cost sheet for Job No. 25.
(c) Prepare the journal entries to record the purchase of raw materials, the factory labor costs incurred, and the manufacturing overhead costs incurred during the month of January.
(d) Prepare the journal entries to record the assignment of direct materials, direct labor, and manufacturing overhead costs to production. In assigning manufacturing overhead costs, use the overhead rate calculated in (a). Post all costs to the job cost sheets as necessary.
(e) Total the job cost sheets for any job(s) completed during the month. Prepare the journal entry (or entries) to record the completion of any job(s) during the month.
(f) Prepare the journal entry (or entries) to record the sale of any job(s) during the month.
(g) What is the balance in the Work in Process Inventory account at the end of the month? What does this balance consist of?
(h) What is the amount of over or underapplied overhead?
Sveta Corporation’s fiscal year ends on November 30. The following accounts are found in its job order cost accounting system for the first month of the new fiscal year.
Raw Materials Inventory
Dec.
1
Beginning balance
(a)
Dec.
31
Requisitions
18,850
31
Purchases
19,225
Dec.
31
Ending balance
7,975
Work in Process Inventory
Dec.
1
Beginning balance
(b)
Dec.
31
Jobs completed
(f)
31
Direct materials
(c)
31
Direct labor
8,800
31
Overhead
(d)
Dec.
31
Ending balance
(e)
Finished Goods Inventory
Dec.
1
Beginning balance
(g)
Dec.
31
Cost of goods sold
(i)
31
Completed jobs
(h)
Dec.
31
Ending balance
(j)
Factory Labor
Dec.
31
Factory wages
12,465
Dec.
31
Wages assigned
(k)
Manufacturing Overhead
Dec.
31
Indirect materials
1,900
Dec.
31
Overhead applied
(m)
31
Indirect labor
(l)
31
Other overhead
1,245
Other data:
1. On December 1, two jobs were in process: Job No. 154 and Job No. 155. These jobs had combined direct materials costs of $9,750 and direct labor costs of $15,000. Overhead was applied at a rate that was 80% of direct labor cost.
2. During December, Job Nos. 156, 157, and 158 were started. On December 31, Job No. 158 was unfinished. This job had charges for direct materials $3,800 and direct labor $4,800, plus manufacturing overhead. All jobs, except for Job No. 158, were completed in December.
3. On December 1, Job No. 153 was in the finished goods warehouse. It had a total cost of $5,000. On December 31, Job No. 157 was the only job finished that was not sold. It had a cost of $4,000.
4. Manufacturing overhead was $230 overapplied in December.
Instructions
List the letters (a) through (m) and indicate the amount pertaining to each letter.
TKE Catering provides catering services to many different corporate clients. Although TKEbids most jobs, some jobs, particularly new ones, are negotiated on a “cost plus” basis. Cost plus means that the buyer is willing to pay the actual cost plus a return (profit) on these costs to TKE.
Anna Tsing, controller for TKE, has recently returned from a meeting where TKE’s president stated that he wanted her to find a way to charge most costs to any project that was on a cost plus basis. The president noted that the company needed more profits to meet its stated goals this period. By charging more costs to the cost plus projects and therefore fewer costs to the jobs that were bid, the company should be able to increase its profit for the current year.
Anna knew why the president wanted to take this action. Rumors were that he was looking for a new position and if the company reported strong profit, the president’s opportunities would be enhanced. Anna also recognized that she could probably increase the cost of certain jobs by changing the basis used to allocate manufacturing overhead.
Instructions
(a) Who are the stakeholders in this situation?
(b) What are the ethical issues in this situation?
You are the management accountant for Knowles Manufacturing. Your company does customcar pentry work and uses a job order cost accounting system. Knowles sends detailed job cost sheets to its customers, along with an invoice. The job cost sheets show the date materials were used, the dollar cost of materials, and the hours and cost of labor. A predetermined overhead application rate is used, and the total overhead applied is also listed.
Saira Ortiz is a customer who recently had custom cabinets installed. Along with her check in payment for the work done, she included a letter. She thanked the company for including the detailed cost information but questioned why overhead was estimated. She stated that she would be interested in knowing exactly what costs were included in overhead, and she thought that other customers would, too.
Instructions
Prepare a letter to Ms. Ortiz (address: 456 Maple Avenue, Boise, Idaho 83702) and tell her why you did not send her information on exact costs of overhead included in her job. Respond to her suggestion that you provide this information.
Lamas Company manufactures pizza sauce through two production departments: Cooking and Canning. In each process, materials and conversion costs are incurred evenly throughout the process. For the month of April, the work in process accounts show the following debits.
The ledger of Penland Company has the following work in process account.
Work in Process—Painting
5/1
Balance
3,590
5/31
Transferred out
?
5/31
Materials
5,160
5/31
Labor
2,740
5/31
Overhead
1,650
5/31
Balance
?
Production records show that there were 400 units in the beginning inventory, 30% complete, 1,100 units started, and 1,200 units transferred out. The beginning work in process had materials cost of $2,040 and conversion costs of $1,550. The units in ending inventory were 40% complete. Materials are entered at the beginning of the painting process.
Instructions
(a) How many units are in process at May 31?
(b) What is the unit materials cost for May?
(c) What is the unit conversion cost for May?
(d) What is the total cost of units transferred out in May?
Kirk Manufacturing Company has two production departments: Cutting and Assembly. July 1 inventories are Raw Materials $4,200, Work in Process—Cutting $2,900, Work in Process—Assembly $10,600, and Finished Goods $31,000. During July, the following transactions occurred.
1. Purchased $62,500 of raw materials on account.
2. Incurred $56,000 of factory labor. (Credit Wages Payable.)
3. Incurred $70,000 of manufacturing overhead; $40,000 was paid and the remainder is unpaid.
4. Requisitioned materials for Cutting $15,700 and Assembly $8,900.
5. Used factory labor for Cutting $29,000 and Assembly $27,000.
6. Applied overhead at the rate of $15 per machine hour. Machine hours were Cutting 1,680 and Assembly 1,720.
7. Transferred goods costing $67,600 from the Cutting Department to the Assembly Department.
8. Transferred goods costing $134,900 from Assembly to Finished Goods.
9. Sold goods costing $150,000 for $200,000 on account.
In Macadoo Company, materials are entered at the beginning of each process. Work in process inventories, with the percentage of work done on conversion costs, and production data for its Sterilizing Department in selected months during 2012 are as follows.
Beginning
Ending
Work in Process
Work in Process
Conversion
Units
Conversion
Month
Units
Cost%
Transferred Out
Units
Cost%
January
–0–
—
7,000
2,000
60
March
–0–
—
12,000
3,000
30
May
–0–
—
16,000
5,000
80
July
–0–
—
10,000
1,500
40
Instructions
(a) Compute the physical units for January and May.
(b) Compute the equivalent units of production for (1) materials and (2) conversion costs for each month.
The Blending Department of Peacock Company has the following cost and production data for the month of April.
Costs:
Work in process, April 1
Direct materials: 100% complete
$100,000
Conversion costs: 20% complete
70,000
Cost of work in process, April 1
$170,000
Costs incurred during production in April
Direct materials
$ 800,000
Conversion costs
362,000
Costs incurred in April
$1,162,000
Units transferred out totaled 14,000. Ending work in process was 1,000 units that are 100% complete as to materials and 40% complete as to conversion costs.
Instructions
(a) Compute the equivalent units of production for (1) materials and (2) conversion costs for the month of April.
(b) Compute the unit costs for the month.
(c) Determine the costs to be assigned to the units transferred out and in ending work in process.
(Learning Objective 1: Analyzing income and investments) Refer to the YUM! Brands,
Inc. financial statements in Appendix A at the end of this book.
1. YUM’s income statement does not mention income from continuing operations. Why not?
2. Take the role of an investor, and suppose you are determining the price to pay for a share of YUM stock. Assume you are considering 3 investment capitalization rates that depend on the risk of an investment in YUM: 5%, 6%, and 7%. Compute your estimated value of a share of YUM stock using each of the 3 capitalization rates. Which estimated value would you base your investment strategy on if you rate YUM risky? If you consider YUM a safe investment? Use basic earnings per share for 2006.
3. Go to YUM! Brands Web site and compare your computed estimates to YUM’s actual stock price. Which of your prices is most realistic? (Challenge)
(Learning Objective 1, 3: Evaluating the quality of earnings, valuing investments, and
analyzing stock outstanding) This case is based on the Pier 1 Imports financial statements in Appendix B at the end of this book.
1. Pier 1’s income statement reports only 1 special item. What is it, and what is its amount for 2006?
2. What is your evaluation of the quality of Pier 1’s earnings? State how you formed your opinion.
3. At the end of 2005, how much would you have been willing to pay for 1 share of Pier 1 stock if you had rated the investment as high risk? as low risk? Use even numbered investment capitalization rates in the range of 6%–12% for your analysis, and use basic earnings per share for continuing operations.
4. Go to Pier 1’s Web site and get the current price of a share of Pier 1 Imports’ common stock. Which value that you estimated in requirement 2 is closest to Pier 1’s actual stock price? (Challenge)
Select a company and research its business. Search the business press for articles about this company. Obtain its annual report by requesting it directly from the company or from the company’s Web site or from Moody’s Industrial Manual (the exercise will be most meaningful if you obtain an actual copy and do not have to use Moody’s).
Required
1. Based on your group’s analysis, come to class prepared to instruct the class on 6 interesting facts about the company that can be found in its financial statements and the related notes. Your group can mention only the obvious, such as net sales or total revenue, net income, total assets, total liabilities, total stockholders’ equity, and dividends, in conjunction with other terms. Once you use an obvious item, you may not use that item again.
2. The group should write a paper discussing the facts that it has uncovered. Limit the paper to 2 double spaced word processed pages.
(Learning Objective 2, 3: Preparing an income statement, balance sheet, and statement of cash flows—indirect method) Vintage Automobiles of Philadelphia, Inc., was formed on January 1, 20X8, when Vintage issued its common stock for $300,000. Early in January, Vintage made the following cash payments:
a. $150,000 for equipment
b. $120,000 for inventory (4 cars at $30,000 each)
c. $20,000 for 20X8 rent on a store building
In February, Vintage purchased 6 cars for inventory on account. Cost of this inventory was $260,000 ($43,333.33 each). Before year end, Vintage paid $208,000 of this debt. Vintage uses the FIFO method to account for inventory. During 20X8, Vintage sold 8 vintage autos for a total of $500,000. Before year end, Vintage collected 80% of this amount. The business employs 3 people. The combined annual payroll is $95,000, of which Vintage owes $4,000 at year end. At the end of the year, Vintage paid income tax of $10,000. Late in 20X8, Vintage declared and paid cash dividends of $11,000. For equipment, Vintage uses the straight line depreciation method, over 5 years, with zero residual value.
Required
1. Prepare Vintage Automobiles of Philadelphia, Inc.’s, income statement for the year ended
December 31, 20X8. Use the single step format, with all revenues listed together and all expenses together.
2. Prepare Vintage’s balance sheet at December 31, 20X8.
3. Prepare Vintage’s statement of cash flows for the year ended December 31, 20X8. Format cash flows from operating activities by using the indirect method.
Tiet Manufacturing uses a job order cost accounting system. On May 1, the company has a balance in Work in Process Inventory of $3,200 and two jobs in process: Job No. 429 $2,000, and Job No. 430 $1,200. During May, a summary of source documents reveals the following.
Materials
Labor
Job Number
Requisition Slips
Time Tickets
429
$2,500
$1,900
430
3,500
3,000
431
4,400
$10,400
7,600
$12,500
General use
800
1,200
$11,200
$13,700
Tiet Manufacturing applies manufacturing overhead to jobs at an overhead rate of 80% of direct labor cost. Job No. 429 is completed during the month.
Instructions
(a) Prepare summary journal entries on May 31 to record: (i) the requisition slips, (ii) the time tickets, (iii) the assignment of manufacturing overhead to jobs, and (iv) the completion of Job No. 429.
(b) Post the entries to Work in Process Inventory, and prove the agreement of the control account with the job cost sheets of the unfinished jobs.
Alma Ortiz and Associates, a CPA firm, uses job order costing to capture the costs of its audit jobs. There were no audit jobs in process at the beginning of November. Listed below are data concerning the three audit jobs conducted during November.
Perez
Rivera
Sota
Direct materials
$600
$400
$200
Auditor labor costs
$5,400
$6,600
$3,375
Auditor hours
72
88
45
Overhead costs are applied to jobs on the basis of auditor hours, and the predetermined overhead rate is $55 per auditor hour. The Perez job is the only incomplete job at the end of November.
Actual overhead for the month was $12,000.
Instructions
(a) Determine the cost of each job.
(b) Indicate the balance of the Work in Process account at the end of November.
(c) Calculate the ending balance of the Manufacturing Overhead account for November.
Angel Company’s fiscal year ends on June 30. The following accounts are found in its job order cost accounting system for the first month of the new fiscal year.
July
1
Beginning balance
Raw Materials Inventory
31
Purchases
19,000
July
31
Requisitions
(a)
July
31
Ending balance
90,400
(b)
Work in Process Inventory
July
1
Beginning balance
(c)
July
31
Jobs completed
(f)
31
Direct materials
75,000
31
Direct labor
(d)
31
Overhead
(e)
July
31
Ending balance
(g)
Finished Goods Inventory
July
1
Beginning balance
(h)
July
31
Wages assigned
(j)
31
Completed jobs
(i)
July
31
Ending balance
(k)
Factory Labor
July
31
Factory wages
(l)
July
31
Wages assigned
(m)
Manufacturing Overhead
July
31
Indirect materials
8,900
July
31
Overhead applied
114,000
31
Indirect labor
16,000
31
Other overhead
(n)
Other data:
1. On July 1, two jobs were in process: Job No. 4085 and Job No. 4086, with costs of $19,000 and $13,200, respectively.
2. During July, Job Nos. 4087, 4088, and 4089 were started. On July 31, only Job No. 4089 was unfinished. This job had charges for direct materials $2,000 and direct labor $1,500, plus manufacturing overhead. Manufacturing overhead was applied at the rate of 120% of direct labor cost.
3. On July 1, Job No. 4084, costing $145,000, was in the finished goods warehouse. On July 31, Job No. 4088, costing $138,000, was in finished goods.
4. Overhead was $3,000 underapplied in July.
Instructions
List the letters (a) through (n) and indicate the amount pertaining to each letter. Show computations.
Benton Printing Corp. uses a job order cost system. The following data summarize the operations related to the first quarter’s production.
1. Materials purchased on account $192,000, and factory wages incurred $87,300.
2. Materials requisitioned and factory labor used by job:
Factory
Job Number
Materials
Labor
A20
$ 35,240
$18,000
A21
42,920
22,000
A22
36,100
15,000
A23
39,270
25,000
General factory use
4,470
7,300
$158,000
$87,300
3. Manufacturing overhead costs incurred on account $39,500.
4. Depreciation on equipment $14,550.
5. Manufacturing overhead rate is 80% of direct labor cost.
6. Jobs completed during the quarter: A20, A21, and A23.
Instructions
Prepare entries to record the operations summarized above. (Prepare a schedule showing the individual cost elements and total cost for each job in item 6.)
Burgio Parts Company uses a job order cost system. For a number of months, there has beenan ongoing rift between the sales department and the production department concerning a special order product, TC 1. TC 1 is a seasonal product that is manufactured in batches of 1,000 units. TC 1 is sold at cost plus a markup of 40% of cost.
The sales department is unhappy because fluctuating unit production costs significantly affect selling prices. Sales personnel complain that this has caused excessive customer complaints and the loss of considerable orders for TC 1.
The production department maintains that each job order must be fully costed on the basis of the costs incurred during the period in which the goods are produced. Production personnel maintain that the only real solution to the problem is for the sales department to increase sales in the slack periods.
Alona Macarty, president of the company, asks you as the company accountant to collect quarterly data for the past year on TC 1. From the cost accounting system, you accumulate the following production quantity and cost data.
Quarter
Costs
1
2
3
4
Direct materials
$100,000
$220,000
$ 80,000
$200,000
Direct labor
60,000
132,000
48,000
120,000
Manufacturing overhead
105,000
123,000
97,000
125,000
Total
$265,000
$475,000
$225,000
$445,000
Production in batches
5
11
4
10
Unit cost (per batch)
$ 53,000
$ 43,182
$ 56,250
$ 44,500
Instructions
With the class divided into groups, answer the following questions.
(a) What manufacturing cost element is responsible for the fluctuating unit costs? Why?
(b) What is your recommended solution to the problem of fluctuating unit cost?
(c) Restate the quarterly data on the basis of your recommended solution.
Bynum Manufacturing uses a job order cost system and applies overhead to production on the basis of direct labor costs. On January 1, 2012, Job No. 50 was the only job in process. The costs incurred prior to January 1 on this job were as follows: direct materials $20,000, direct labor $12,000, and manufacturing overhead $16,000. As of January 1, Job No. 49 had been completed at a cost of $90,000 and was part of finished goods inventory. There was a $15,000 balance in the Raw Materials Inventory account.
During the month of January, Bynum Manufacturing began production on Jobs 51 and 52, and completed Jobs 50 and 51. Jobs 49 and 50 were also sold on account during the month for $122,000 and $158,000, respectively. The following additional events occurred during the month.
1. Purchased additional raw materials of $90,000 on account.
2. Incurred factory labor costs of $65,000. Of this amount, $16,000 related to employer payroll taxes.
$15,000; depreciation expense on equipment $19,000; and various other manufacturing overhead costs on account $20,000.
4. Assigned direct materials and direct labor to jobs as follows.
Job No.
Direct Materials
Direct Labor
50
$10,000
$ 5,000
51
39,000
25,000
52
30,000
20,000
Instructions
(a) Calculate the predetermined overhead rate for 2012, assuming Bynum Manufacturing estimates total manufacturing overhead costs of $1,050,000, direct labor costs of $700,000, and direct labor hours of 20,000 for the year.
(b) Open job cost sheets for Jobs 50, 51, and 52. Enter the January 1 balances on the job cost sheet for Job No. 50.
(c) Prepare the journal entries to record the purchase of raw materials, the factory labor costs incurred, and the manufacturing overhead costs incurred during the month of January.
(d) Prepare the journal entries to record the assignment of direct materials, direct labor, and manufacturing overhead costs to production. In assigning manufacturing overhead costs, use the overhead rate calculated in (a). Post all costs to the job cost sheets as necessary.
(e) Total the job cost sheets for any job(s) completed during the month. Prepare the journal entry (or entries) to record the completion of any job(s) during the month.
(f) Prepare the journal entry (or entries) to record the sale of any job(s) during the month.
(g) What is the balance in the Finished Goods Inventory account at the end of the month? What does this balance consist of?
(h) What is the amount of over or underapplied overhead?
Cooke Corporation incurred the following transactions.
1. Purchased raw materials on account $46,300.
2. Raw Materials of $36,000 were requisitioned to the factory. An analysis of the materials requisition slips indicated that $6,800 was classified as indirect materials.
3. Factory labor costs incurred were $53,900, of which $49,000 pertained to factory wages payable and $4,900 pertained to employer payroll taxes payable.
4. Time tickets indicated that $48,000 was direct labor and $5,900 was indirect labor.
5. Overhead costs incurred on account were $80,500.
6. Manufacturing overhead was applied at the rate of 150% of direct labor cost.
7. Goods costing $88,000 were completed and transferred to finished goods.
8. Finished goods costing $75,000 to manufacture were sold on account for $103,000.
During February, Cardella Manufacturing works on two jobs: A16 and B17. Summary data concerning these jobs are as follows.
Manufacturing Overhead
Cardella Manufacturing uses a predetermined overhead rate with direct laborcosts as the activity base. It expects annual overhead costs to be $760,000 and direct labor costs for the year to be $950,000.
Manufacturing Costs Incurred
Purchased $54,000 of raw materials on account.
Factory labor $76,000, plus $4,000 employer payroll taxes.
Manufacturing overhead exclusive of indirect materials and indirect labor $59,800.
Assignment of Costs
Direct materials:
Job A16 $27,000, Job B17 $21,000
Indirect materials:
$3,000
Direct labor:
Job A16 $52,000, Job B17 $26,000
Indirect labor:
$2,000
Job A16 was completed and sold on account for $150,000. Job B17 was only partially completed.
Instructions
(a) Compute the predetermined overhead rate.
(b) Journalize the February transactions in the sequence followed in the chapter.
(c) What was the amount of under or over applied manufacturing overhead?
For the year ended December 31, 2012, the job cost sheets of Guo Company contained the following data
Job
Direct
Direct
Manufacturing
Total
Number
Explanation
Materials
Labor
Overhead
Costs
7650
Balance 1/1
$18,000
$20,000
$25,000
$ 63,000
Current year’s costs
32,000
36,000
45,000
113,000
7651
Balance 1/1
12,000
16,000
20,000
48,000
Current year’s costs
30,000
40,000
50,000
120,000
7652
Current year’s costs
45,000
68,000
85,000
198,000
Other data:
1. Raw materials inventory totaled $20,000 on January 1. During the year, $100,000 of raw materials were purchased on account.
2. Finished goods on January 1 consisted of Job No. 7648 for $93,000 and Job No. 7649 for $62,000.
3. Job No. 7650 and Job No. 7651 were completed during the year.
4. Job Nos. 7648, 7649, and 7650 were sold on account for $490,000.
5. Manufacturing overhead incurred on account totaled $135,000.
6. Other manufacturing overhead consisted of indirect materials $12,000, indirect labor $18,000, and depreciation on factory machinery $19,500.
Instructions
(a) Prove the agreement of Work in Process Inventory with job cost sheets pertaining to unfinished work. (Hint: Use a single T account for Work in Process Inventory.) Calculate each of the following, then post each to the T account: (1) beginning balance, (2) direct materials, (3) direct labor, (4) manufacturing overhead, and (5) completed jobs.
(b) Prepare the adjusting entry for manufacturing overhead, assuming the balance is allocated entirely to cost of goods sold.
(c) Determine the gross profit to be reported for 2012.
For the year ended December 31, 2012, the job cost sheets of Heimer Company contained the following data.
Job
Direct
Direct
Manufacturing
Total
Number
Explanation
Materials
Labor
Overhead
Costs
7640
Balance 1/1
$25,000
$24,000
$28,800
$ 77,800
Current year’s costs
30,000
36,000
43,200
109,200
7641
Balance 1/1
11,000
18,000
21,600
50,600
Current year’s costs
43,000
48,000
57,600
148,600
7642
Current year’s costs
48,000
55,000
66,000
169,000
Other data:
1. Raw materials inventory totaled $15,000 on January 1. During the year, $140,000 of raw materials were purchased on account.
2. Finished goods on January 1 consisted of Job No. 7638 for $87,000 and Job No. 7639 for $92,000.
3. Job No. 7640 and Job No. 7641 were completed during the year.
4. Jobs 7638, 7639, and 7641 were sold on account for $530,000.
5. Manufacturing overhead incurred on account totaled $120,000.
6. Other manufacturing overhead consisted of indirect materials $14,000, indirect labor $20,000, and depreciation on factory machinery $8,000.
Instructions
(a) Prove the agreement of Work in Process Inventory with job cost sheets pertaining to unfinished work. (Hint: Use a single T account for Work in Process Inventory.) Calculate each of the following, then post each to the T account: (1) beginning balance, (2) direct materials, (3) direct labor, (4) manufacturing overhead, and (5) completed jobs.
(b) Prepare the adjusting entry for manufacturing overhead, assuming the balance is allocated entirely to cost of goods sold.
(c) Determine the gross profit to be reported for 2012.
Forte Company begins operations on April 1. Information from job cost sheets shows the following.
Manufacturing Costs Assigned
Job
Month
Number
April
May
June
Completed
10
$5,200
$4,400
May
11
4,100
3,900
$3,000
June
12
1,200
April
13
4,700
4,500
June
14
4,900
3,600
Not complete
Job 12 was completed in April. Job 10 was completed in May. Jobs 11 and 13 were completed in June. Each job was sold for 25% above its cost in the month following completion.
Instructions
(a) What is the balance in Work in Process Inventory at the end of each month?
(b) What is the balance in Finished Goods Inventory at the end of each month?
(c) What is the gross profit for May, June, and July?
Founded in 1970, Parlex Corporation is a world leader in the design and manufacture of flexible interconnect products. Utilizing proprietary and patented technologies, Parlex produces custom flexible interconnects including flexible circuits, polymer thick film, laminated cables, and value added assemblies for sophisticated electronics used in automotive, telecommunications, computer, diversified electronics, and aerospace applications. In addition to manufacturing sites in Methuen, Massachusetts; Salem, New Hampshire; Cranston, Rhode Island; San Jose, California; Shanghai, China; Isle of Wight, UK; and Empalme, Mexico, Parlex has logistic support centers and strategic alliances throughout North America, Asia, and Europe.
Parlex Company
Notes to the Financial Statements
The Company’s products are manufactured on a job order basis to customers’ specifications. Customers submit requests for quotations on each job, and the Company prepares bids based on its own cost estimates. The Company attempts to refl ect the impact of changing costs when establishing prices. However, during the past several years, the market conditions for flexible circuits and the resulting price sensitivity haven’t always allowed this to transpire. Although still not satisfactory, the Company was able to reduce the cost of products sold as a percentage of sales to 85% this year versus 87% that was experienced in the two immediately preceding years. Management continues to focus on improving operational efficiency and further reducing costs.
Instructions
(a) Parlex management discusses the job order cost system employed by their company. What are several advantages of using the job order approach to costing?
(b) Contrast the products produced in a job order environment, like Parlex, to those produced when process cost systems are used.
Hsung Manufacturing Company uses a job order cost system in each of its three manufacturing departments. Manufacturing overhead is applied to jobs on the basis of direct labor cost in Department E, direct labor hours in Department G, and machine hours in Department I. In establishing the predetermined overhead rates for 2012, the following estimates were made for the year.
Department
E
G
I
Manufacturing overhead
$1,050,000
$1,500,000
$840,000
Direct labor costs
$1,500,000
$1,250,000
$450,000
Direct labor hours
100,000
125,000
40,000
Machine hours
400,000
500,000
120,000
During January, the job cost sheets showed the following costs and production data.
Department
E
G
I
Direct materials used
$140,000
$126,000
$78,000
Direct labor costs
$120,000
$110,000
$37,500
Manufacturing overhead incurred
$ 89,000
$124,000
$74,000
Direct labor hours
8,000
11,000
3,500
Machine hours
34,000
45,000
10,400
Instructions
(a) Compute the predetermined overhead rate for each department.
(b) Compute the total manufacturing costs assigned to jobs in January in each department.
(c) Compute the under or overapplied overhead for each department at January 31.
The following information was taken from the ledger of Maxim, Inc.:
Prior period adjustment credit to Retained Earnings
$ 5,000
Treasury stock, common (5,000 shares at cost)
$ 25,000
Gain on sale of plant assets
21,000
Selling expenses
78,000
Cost of goods sold
380,000
Common stock, no par, 45,000 shares issued
180,000
Income tax expense (saving):
Sales revenue
620,000
Continuing operations
32,000
Interest expense
30,000
Discontinued operations
8,000
Extraordinary gain
26,000
Extraordinary gain
10,000
Income from discontinued operations
20,000
Preferred stock, 8%, $100 par, 500 shares issued
50,000
Loss due to lawsuit
11,000
Dividends
16,000
General expenses
62,000
Retained earnings, beginning, as originally reported
103,000
Required
Prepare a single step income statement (with all revenues and gains grouped together) and a statement of retained earnings for Maxim, Inc., for the current year ended December 31, 20XX. Include the earnings per share presentation and show computations. Assume no changes in the stock accounts during the year.
Onstar GPS Systems earned income before tax of $50,000. Taxable income was 40,000, and the income tax rate was 40%. Onstar recorded income tax with this journal entry:
(Learning Objective 3: Reporting a prior period adjustment) iFlash, Inc., was set to report the following statement of retained earnings for the year ended December 31, 20X1.
iFlash, Inc. Statement of Retained Earnings Year Ended December 31, 20X1
Retained earnings, December 31, 20X0
$140,000
Net income for 20X1
91,000
Dividends for 20X1
(14,000)
Retained earnings, December 31, 20X1
$217,000
Before issuing its 20X1 financial statements, iFlash learned that net income of 20X0 was overstated by $16,000. Prepare iFlash’s 20X1 statement of retained earnings to show the correction of the error—that is, the prior period adjustment.
(Learning Objective 1: Preparing and using a complex income statement) Outback
Cycles, Inc., reported a number of special items on its income statement. The following data, listed in no particular order, came from Outback’s financial statements (amounts in thousands):
Income tax expense (saving):
Net sales
13
Continuing operations
$610
Foreign currency translation adjustment
$13,800
Discontinued operations
50
Extraordinary loss
360
Extraordinary loss
(3)
Income from discontinued operations
270
Unrealized gain on available for sale investments
40
Dividends declared and paid
680
Short term investments
35
Total operating expenses
12,250
Required
Show how the Outback Cycles, Inc., income statement for the year ended September 30, 20X8 should appear. Omit earnings per share.
(Learning Objective 1: Computing and using earnings per share) Midtown Holding
Company operates numerous businesses, including motel, auto rental, and real estate companies. Year 20X6 was interesting for Midtown, which reported the following on its income statement (in millions):
Net revenues
$3,930
Total expenses and other
3,354
Income from continuing operations
576
Discontinued operations, net of tax
84
Income before extraordinary item, net of tax
660
Extraordinary gain, net of tax
8
Net income
$ 668
During 20X6, Midtown had the following (in millions, except for par value per share):
Common stock, $0.01 par value, 900 shares issued
$ 9
Treasury stock, 180 shares at cost
(3,568)
Required
Show how Midtown should report earnings per share for 20X6.
(Learning Objective 3: Preparing a staement of stockholders’ equity) At December 31, 20X4, Lake Air Mall, Inc., reported stockholders’ equity as follows:
Common stock, $1 par, 500,000 shares authorized, 320,000 shares issued
$ 320,000
Additional paid in capital
600,000
Retained earnings
680,000
$1,600,000
During 20X5, Lake Air Mall completed these transactions (listed in chronological order):
a. Declared and issued a 5% stock dividend on the outstanding stock. At the time, Lake
Air Mall stock was quoted at a market price of $10 per share.
b. Issued 20,000 shares of common stock at the price of $12 per share.
c. Net income for the year, $340,000.
d. Declared cash dividends of $100,000.
Required
Prepare Lake Air Mall, Inc.’s, statement of stockholders’ equity for 20X5 .
(Learning Objective 3: Using a company’s statement of stockholders’ equity) Spring Water Company reported the following items on its statement of shareholders’ equity for the year ended December 31, 20X9 (in thousands):
$1 Par Common Stock
Capital in Excess of Par Value
Retained Earnings
Accumulated Other Comprehensive Income
Total Shareholders’ Equity
Balance, Dec. 31, 20X8
$380
$1,590
$3,500
$9
$5,479
Net earnings
1,020
Unrealized gain on investments
Issuance of stock
110
560
1
Cash dividends
Balance, Dec.31, 20X9
(220)
Required
1. Determine the December 31, 20X9, balances in Spring Water’s shareholders’ equity accounts and total shareholders’ equity on this date.
2. Spring Water’s total liabilities on December 31, 20X9 are $5,000 thousand. What is
Spring Water’s debt ratio on this date?
3. Was there a profit or a loss for the year ended December 31, 20X9? How can you tell?
4. At what price per share did Spring Water issue common stock during 20X9?
(Learning Objective 4: Identifying responsibility and standards for the financial statements) The annual report of Apple Computer, Inc., included the following:
1. Who is responsible for Apple’s financial statements?
2. By what accounting standard are the financial statements prepared?
3. Identify 1 concrete action that Apple management takes to fulfill its responsibility for the reliability of the company’s financial information.
4. Which entity gave an outside, independent opinion on the Apple financial statements?
Where was this entity located, and when did it release its opinion to the public?
5. Exactly what did the audit cover? Give names and dates.
6. By what standard did the auditor conduct the audit?
7. What was the auditor’s opinion of Apple’s financial statements?
(Learning Objective 1: Preparing a complex income statement) The following information was taken from the records of Filner Cosmetics, Inc., at December 31, 20X8.
Prior period adjustment debit to Retained Earnings
$ 4,000
Dividends on common stock
$37,000
Income tax expense (saving):
Interest expense
23,000
Continuing operations
28,000
Gain on lawsuit settlement
8,000
Income from discontinued operations
2,000
Dividend revenue
11,000
Extraordinary loss
(10,800)
Treasury stock, common (2,000 shares at cost)
28,000
Loss on sale of plant assets
10,000
General expenses
71,000
Income from discontinued operations
7,000
Sales revenue
567,000
Preferred stock, 6%, $25 par, 4,000 shares issued
100,000
Retained earnings, beginning, as originally reported
63,000
Extraordinary loss
22,400
Selling expenses
87,000
Cost of goods sold
319,000
Common stock, no par, 22,000 shares authorized and issued
350,000
Required
1. Prepare Filner Cosmetics’ single step income statement, which lists all revenues together and all expenses together, for the fiscal year ended December 31, 20X8. Include earnings per share data.
2. Evaluate income for the year ended December 31, 20X8. Filner’s top managers hoped to earn income from continuing operations equal to 10% of sales. (Challenge)
(Learning Objective 1: Using income data to make an investment decision) Filner Cosmetics in Problem P11 35A holds significant promise for carving a niche in its industry. A group of Canadian investors is considering purchasing the company’s outstanding common stock. Filner’s stock is currently selling for $32 per share. A Financial Markets Magazine story predicted the company’s income is bound to grow. It appears that Filner can earn at least its current level of income for the indefinite future. Based on this information, the investors think that an appropriate investment capitalization rate for estimating the value of Filner’s common stock is 8%. How much will this belief lead the investors to offer for Filner Cosmetics? Will Filner’s existing stockholders be likely to accept this offer? Explain your answers.
(Learning Objective 1: Computing earnings per share and estimating the price of a stock) Turnaround Specialists, Ltd., (TSL) specializes in taking underperforming companies to a higher level of performance. TSL’s capital structure at December 31, 20X7 included 10,000 shares of $2.50 preferred stock and 120,000 shares of common stock. During 20X8, TSL issued common stock and ended the year with 127,000 shares of common stock outstanding. Average common shares outstanding during 20X8 were 123,500. Income from continuing operations during 20X8 was $219,000. The company discontinued a segment of the business at a loss of $69,000, and an extraordinary item generated a gain of $49,500. All amounts are after income tax.
Required
1. Compute TSL’s earnings per share. Start with income from continuing operations.
2. Analysts believe TSL can earn its current level of income for the indefinite future.
Estimate the market price of a share of TSL common stock at investment capitalization rates of 6%, 8%, and 10%. Which estimate presumes an investment in TSL is the most risky? How can you tell?
(Learning Objective 1: Preparing a corrected income statement, including comprehensive income) Richard Wright, accountant for Sweetie Pie Foods, Inc., was injured in an auto accident. Another employee prepared the following income statement for the fiscal year ended June 30, 20X7:
Sweetie Pie Foods, Inc. Income Statement June 30, 20X7
Revenue and gains:
Sales
$733,000
Paid in capital in excess of par common
100,000
Total revenues and gains
833,000
Expenses and losses:
Cost of goods sold
$383,000
Selling expenses
103,000
General expenses
74,000
Sales returns
22,000
Unrealized loss on available for sale investments
4,000
Dividends paid
15,000
Sales discounts
10,000
Income tax expense
56,400
Total expenses and losses
667,400
Income from operations
165,600
Other gains and losses:
Extraordinary gain
30,000
Loss on discontinued operations
(15,000)
Total other gains (losses)
15,000
Net income
$180,600
Earnings per share
$4.52
The individual amounts listed on the income statement are correct. However, some accounts are reported incorrectly, and some accounts do not belong on the income statement at all. Also, income tax (40%) has not been applied to all appropriate figures. Sweetie Pie Foods issued 44,000 shares of common stock back in 20X1 and held 4,000 shares as treasury stock all during the fiscal year 20X7.
Required
Prepare a corrected statement of income (single step, which lists all revenues together and all expenses together), including comprehensive income, for fiscal year 20X7. Include earnings per share.
(Learning Objective 2: Accounting for a corporation’s income tax) The accounting (not the income tax) records of Haynes Publications, Inc., provide the comparative income statement for 20X1 and 20X2, respectively:
20X1
20X2
Total revenue
$600,000
$720,000
Expenses:
Cost of goods sold
$290,000
$310,000
Operating expenses
180,000
190,000
Total expenses before tax
470,000
500,000
Pretax accounting income
$130,000
$220,000
Taxable income for 20X1 includes these modifications from pretax accounting income:
a. Additional taxable income of $10,000 for rent revenue earned in 20X2 but taxed in 20X1.
b. Additional depreciation expense of $20,000 for MACRS tax depreciation. The income tax rate is $40%.
Required
1. Compute Haynes’ taxable income for 20X1.
2. Journalize the corporation’s income taxes for 20X1.
3. Prepare the corporation’s income statement for 20X1.
(Learning Objective 3: Using a statement of stockholders’ equity) Asian Food
Specialties, Inc., reported the following statement of stockholders’ equity for the year ended June 30, 20X7:
Asian Food Specialties, Inc. Statement of Stockholders’ Equity Year Ended June 30, 20X7
(In millions)
Common Stock
Additional Paid in Capital
Retained Earnings
Treasury Stock
Total
Balance, June 30, 20X6
$175
$2,118
$1,702
$(18)
$3,977
Net income
540
540
Cash dividends
(117)
(117)
Issuance of stock (5 shares)
5
46
51
Stock dividend
18
180
(198)
—
Sale of treasury stock
14
6
20
Balance, June 30, 20X7
$198
$2,358
$1,927
$(12)
$4,471
Required
Answer these questions about Asian Food Specialties’ stockholders’ equity transactions.
1. The income tax rate is 40%. How much income before income tax did Asian Food
Specialties report on the income statement?
2. What is the par value of the company’s common stock?
3. At what price per share did Asian Food Specialties issue its common stock during the year?
4. What was the cost of treasury stock sold during the year? What was the total selling price of the treasury stock sold? What was the increase in total stockholders’ equity?
5. Asian Food Specialties’ statement of stockholders’ equity lists the stock transactions in the order in which they occurred. What was the percentage of the stock dividend? Round to the nearest percentage.
(Learning Objective 1: Preparing a corrected income statement, including comprehensive income) Rhonda Sparks, accountant for Canon Pet Supplies, was injured in a skiing accident. Another employee prepared the accompanying income statement for the year ended December 31, 20X1. The individual amounts listed on the income statement are correct. However, some accounts are reported incorrectly, and 1 account does not belong on the income statement at all. Also, income tax (40%) has not been applied to all appropriate figures. Canon issued 52,000 shares of common stock in 20X0 and held 2,000 shares as treasury stock all during 20X1.
Canon Pet Supplies Income Statement 20X1
Revenue and gains:
Sales
$362,000
Unrealized gain on available for sale investments
10,000
Paid in capital in excess of par common
80,000
Total revenues and gains
452,000
Expenses and losses:
Cost of goods sold
$103,000
Selling expenses
56,000
General expenses
61,000
Sales returns
11,000
Dividends paid
7,000
Sales discounts
6,000
Income tax expense
50,000
Total expenses and losses
294,000
Income from operations
158,000
Other gains and losses:
Extraordinary loss
$(20,000)
Loss on discontinued operations
(3,000)
Total other losses
(23,000)
Net income
$135,000
Earnings per share
$2.70
Required
Prepare a corrected statement of income (single step, which lists all revenues together and all expenses together), including comprehensive income for 20X1. Include earnings per share.
(Learning Objective 2: Accounting for a corporation’s income tax) The accounting (not the income tax) records of Colorado Rafting, Inc., provide the following comparative income statement for 20X4 and 20X5, respectively.
20X4
20X5
Total revenue
$900,000
$990,000
Expenses:
Cost of goods sold
$430,000
$460,000
Operating expenses
270,000
280,000
Total expenses before tax
700,000
740,000
Pretax accounting income
$200,000
$250,000
Taxable income for 20X4 includes these modifications from pretax accounting income:
a. Additional taxable income of $15,000 for accounting income earned in 20X5 but
taxed in 20X4.
b. Additional depreciation expense of $30,000 for MACRS tax depreciation. The income tax rate is $40%.
Required
1. Compute Colorado Rafting’s taxable income for 20X4.
2. Journalize the corporation’s income taxes for 20X4.
3. Prepare the corporation’s income statement for 20X4.
(Learning Objective 3: Using a statement of stockholders’ equity) Datacom Services, Inc., reported the following statement of stockholders’ equity for the year ended October 31, 20X7.
Datacom Services, Inc. Statement of Stockholders’ Equity Year Ended October 31, 20X7
(In millions)
Common Stock
Additional Paid in Capital
Retained Earnings
Treasury Stock
Total
Balance, Oct. 31, 20X6
$427
$1,622
$904
$(117)
$2,836
Net income
360
360
Cash dividends
(194)
(194)
Issuance of stock (13 shares)
13
36
49
Stock dividend
44
122
(166)
–
Sale of treasury stock
11
9
20
Balance, Oct. 31, 20X7
$484
$1,791
$904
$108
$3,071
Required
Answer these questions about Datacom Services’ stockholders’ equity transactions:
1. The income tax rate is 40%. How much income before income tax did Datacom report on the income statement?
2. What is the par value of the company’s common stock?
3. At what price per share did Datacom Services issue its common stock during the year?
4. What was the cost of treasury stock sold during the year? What was the selling price of the treasury stock sold? What was the increase in total stockholders’ equity?
5. Datacom Services’ statement lists the stock transactions in the order they occurred. What was the percentage of the stock dividend?
(Learning Objective 1: Evaluating the components of income) Prudhoe Bay Oil Co. is having its initial public offering (IPO) of company stock. To create public interest in its stock, Prudhoe Bay’s chief financial officer has blitzed the media with press releases. One, in particular, caught your eye. On November 19, Prudhoe Bay announced unaudited earnings per share (EPS) of $1.19, up 89% from last year’s EPS of $0.63. An 89% increase in EPS is outstanding! Before deciding to buy Prudhoe Bay stock, you investigated further and found that the company omitted several items from the determination of unaudited EPS, as follows:
• Unrealized loss on available for sale investments, $0.06 per share
• Gain on sale of building, $0.05 per share
• Prior period adjustment, increase in retained earnings $1.10 per share
• Restructuring expenses, $0.29 per share
• Loss on settlement of lawsuit begun 5 years ago, $0.12 per share
• Lost income due to employee labor strike, $0.24 per share
• Income from discontinued operations, $0.09 per share
Wondering how to treat these “special items,” you called your stockbroker at Merrill Lynch. She thinks that these items are nonrecurring and outside Prudhoe Bay’s core operations. Furthermore, she suggests that you ignore the items and consider Prudhoe Bay’s earnings of $1.19 per share to be a good estimate of long term profitability.Required
What EPS number will you use to predict Prudhoe Bay’s future profits? Show your work, and explain your reasoning for each item.
(Learning Objective 1, 2: Accounting for available for sale and equity method investments) The beginning balance sheet of NASDOQ Corporation included the following:
Long Term Investment in MSC Software (equity method investment)
$619,000
NASDOQ completed the following investment transactions during the year:
Mar.16
Purchased 2,000 shares of ATI, Inc., common stock as a longterm available for sale investment, paying $12.25 per share.
May.21
Received cash dividend of $0.75 per share on the ATI investment.
Aug. 17
Received cash dividend of $81,000 from MSC Software.
Dec. 31
Received annual report from MSC Software; net income for the year was $550,000. Of this amount, NASDOQ’s proportion is 22%.
Required
1. Record the transactions in the journal of NASDOQ Corporation.
2. Post entries to the T account for Long Term Investment in MSC and determine its balance at December 31.
3. Show how to report the Long Term Available for Sale Investments and the Long Term Investment in MSC accounts on NASDOQ’s balance sheet at December 31.
(Learning Objective 3: Analyzing consolidated financial statements) This problem demonstrates the dramatic effect that consolidation accounting can have on a company’s ratios. Ford Motor Company (Ford) owns 100% of Ford Motor Credit Corporation (FMCC), its financing subsidiary. Ford’s main operations consist of manufacturing automotive products. FMCC mainly helps people finance the purchase of automobiles from Ford and its dealers. The 2 companies’ individual balance sheets are adapted and summarized as follows (amounts in billions):
Ford (Parent)
FMCC (Subsidiary)
Total assets
$89.6
$170.5
Total liabilities
$65.1
$156.9
Total stockholders’ equity
24.5
13.6
Total liabilities and equity
$89.6
$170.5
Assume that FMCC’s liabilities include $1.6 billion owed to Ford, the parent company.
Required
1. Compute the debt ratio of Ford Motor Company considered alone.
2. Determine the consolidated total assets, total liabilities, and stockholders’ equity of Ford Motor Company after consolidating the financial statements of FMCC into the totals of Ford, the parent company.
3. Recompute the debt ratio of the consolidated entity. Why do companies prefer not to consolidate their financing subsidiaries into their own financial statements?
(Learning Objective 4: Accounting for a bond investment purchased at a premium)
Insurance companies and pension plans hold large quantities of bond investments. Wolverine Insurance Corp. purchased $600,000 of 6% bonds of Eaton, Inc., for 106 on March 1, 20X4. These bonds pay interest on March 1 and September 1 each year. They mature on March 1, 20X8. At December 31, 20X4, the market price of the bonds is 103.5.
Required
1. Journalize Wolverine’s purchase of the bonds as a long term investment on March 1,
20X4 (to be held to maturity), receipt of cash interest, and amortization of the bond
investment at December 31, 20X4. The straight line method is appropriate for amortizing the bond investment.
2. Show all financial statement effects of this long term bond investment on Wolverine Insurance Corp.’s balance sheet and income statement at December 31, 20X4.
(Learning Objective 5: Recording foreign currency transactions and reporting the transaction gain or loss) Suppose Bridgestone Corporation completed the following international transactions:
May 1
Sold inventory on account to Fiat, the Italian automaker, for E82,000. The exchange rate of the euro is $1.30, and Fiat demands to pay in euros.
10
Purchased supplies on account from a Canadian company at a price of Canadian $50,000. The exchange rate of the Canadian dollar is $0.70, and payment will be in Canadian dollars.
17
Sold inventory on account to an English firm for 100,000 British pounds. Payment will be in pounds, and the exchange rate of the pound is $1.90.
22
Collected from Fiat. The exchange rate is E1 = $1.33.
June 18
Paid the Canadian company. The exchange rate of the Canadian dollar is $0.69.
24
Collected from the English firm. The exchange rate of the British pound is $1.87.
Required
1. Record these transactions in Bridgestone’s journal and show how to report the transaction gain or loss on the income statement.
2. How will what you learned in this problem help you structure international transactions? (Challenge)
(Learning Objective 5: Measuring and explaining the foreign currency translation adjustment) Assume that Intel has a subsidiary company based in Japan.
Required
1. Translate into dollars the foreign currency balance sheet of the Japanese subsidiary of Intel.
Yen
Assets
300,000,000
Liabilities
80,000,000
Stockholders’ equity:
20,000,000
Common stock
200,000,000
Retained earnings
300,000,000
When Intel acquired this subsidiary, the Japanese yen was worth $0.0064. The current exchange rate is $0.0083. During the period when the subsidiary earned its income, the average exchange rate was $0.0070 per yen. Before you perform the foreign currency translation calculations, indicate whether Intel has experienced a positive or a negative translation adjustment. State whether the adjustment is a gain or a loss, and show where it is reported in the financial statements.
2. To which company does the foreign currency translation adjustment “belong”? In which company’s financial statements will the translation adjustment be reported?
(Learning Objective 6: Using a cash flow statement) Excerpts from Smart Pro,
Inc.’s, statement of cash flows appear as follows:
Smart Pro, Inc. Consolidated Statement of Cash Flows (Adapted, partial) Years Ended December 31,
(In millions)
20X8
20X7
Cash and cash equivalents, beginning of year
$ 2,976
$ 3,695
Net cash provided by operating activities
8,654
12,827
Cash flows provided by (used for) investing activities:
Additions to property, plant, and equipment
(7,309)
(6,674)
Acquisitions of other companies
(883)
(2,317)
Purchases of available for sale investments
(7,141)
(17,188)
Sales of available for sale investments
15,138
16,144
Net cash (used for) investing activities
(195)
(10,035)
Cash flows provided by (used for) financing activities:
Borrowing
329
215
Retirement of long term debt
(10)
(46)
Proceeds from issuance of stock
762
797
Repurchase and retirement of common stock
(4,008)
(4,007)
Payment of dividends to stockholders
(538)
(470)
Net cash (used for) financing activities
(3,465)
(3,511)
Net increase (decrease) in cash and cash equivalents
4,994
(719)
Cash and cash equivalents, end of year
$ 7,970
$ 2,976
Required
As the chief executive officer of Smart Pro, Inc., your duty is to write the management letter to your stockholders to explain Smart Pro’s investing activities during 20X8. Compare the company’s level of investment with preceding years and indicate the major way the company financed its investments during 20X8. Net income for 20X8 was $1,291 million.
(Learning Objective 1, 2: Reporting investments on the balance sheet and the related revenue on the income statement) Homestead Financial Corporation owns numerous investments in the stock of other companies. Homestead Financial completed the following long term investment transactions:
20X4
May 1
Purchased 8,000 shares, which make up 25% of the common stock of Mars Company at total cost of $450,000.
Sep. 15
Received a cash dividend of $1.40 per share on the Mars investment.
Oct. 12
Purchased 1,000 shares of Mercury Corporation common stock as an available for sale investment paying $22.50 per share.
Dec. 14
Received a cash dividend of $0.75 per share on the Mercury investment.
31
Received annual report from Mars Company. Net income for the year was $350,000.
At year end the current market value of the Mercury stock is $19,200. The market value of the Mars stock is $740,000.
Required
1. For which investment is current market value used in the accounting? Why is market value used for 1 investment and not the other?
2. Show what Homestead Financial will report on its year end balance sheet and income statement for these investments. (It is helpful to use a T account for the Long Term Investment in Mars Stock account.) Ignore income tax.
(Learning Objective 1, 2: Accounting for available for sale and equity method investments) The beginning balance sheet of Dealmaker Securities included the following:
Long Term Investments in Affiliates (equity method investments)
$409,000
Dealmaker completed the following investment transactions during the year:
Feb. 16
Purchased 10,000 shares of BCM Software common stock as a long term available for sale investment, paying $9.25 per share.
May 14
Received cash dividend of $0.82 per share on the BCM investment.
Oct. 15
Received cash dividend of $29,000 from an affiliated company.
Dec. 31
Received annual reports from affiliated companies. Their total net income for the year was $620,000. Of this amount, Dealmaker’s proportion is 25%.
The market values of Dealmaker’s investments are BCM, $89,000; affiliated companies, $947,000.
Required
1. Record the transactions in the journal of Dealmaker Securities.
2. Post entries to the Long Term Investments in Affiliates T account and determine its balance at December 31.
3. Show how to report Long Term Available for Sale Investments and Long Term Investments in Affiliates on Dealmaker’s balance sheet at December 31.
(Learning Objective 3: Analyzing consolidated financial statements) This problem demonstrates the dramatic effect that consolidation accounting can have on a company’s ratios. General Motors Corporation (GM) owns 100% of General Motors Acceptance Corporation (GMAC), its financing subsidiary. GM’s main operations consist of manufacturing automotive products. GMAC mainly helps people finance the purchase of automobiles from GM and its dealers. The 2 companies’ individual balance sheets are summarized as follows (amounts in billions):
General Motors (Parent)
GMAC (Subsidiary)
Total assets
$132.6
$94.6
Total liabilities
$109.3
$86.3
Total stockholders’ equity
23.3
8.3
Total liabilities and equity
$132.6
$94.6
Assume that GMAC’s liabilities include $5.1 billion owed to General Motors, the parent company.
Required
1. Compute the debt ratio of GM Corporation considered alone.
2. Determine the consolidated total assets, total liabilities, and stockholders’ equity of GM after consolidating the financial statements of GMAC into the totals of GM, the parent company.
3. Recompute the debt ratio of the consolidated entity. Why do companies prefer not to consolidate their financing subsidiaries into their own financial statements?
(Learning Objective 3: Consolidating a wholly owned subsidiary) Murdoch Corporation paid $179,000 to acquire all the common stock of Newswire, Inc., and Newswire owes Murdoch $55,000 on a note payable. Immediately after the purchase on June 30, 20X6, the 2 companies’ balance sheets were as follows:
Murdoch
Newswire
Assets
Cash
$ 48,000
$ 32,000
Accounts receivable, net
264,000
43,000
Note receivable from Newswire
55,000
—
Inventory
193,000
153,000
Investment in Newswire
179,000
—
Plant assets, net
105,000
138,000
Total
$844,000
$366,000
Liabilities and Stockholders’ Equity
Accounts payable
$ 76,000
$ 37,000
Notes payable
118,000
123,000
Other liabilities
174,000
27,000
Common stock
82,000
90,000
Retained earnings
394,000
89,000
Total
$844,000
$366,000
Required
Prepare Murdoch’s consolidated balance sheet. (It is sufficient to complete a consolidation work sheet.)
(Learning Objective 4: Accounting for a bond investment purchased at a discount) Financial institutions hold large quantities of bond investments. Suppose Morgan Stanley purchases $500,000 of 6% bonds of General Components Corporation for 96 on January 31, 20X0. These bonds pay interest on January 31 and July 31 each year. They mature on July 31, 20X8. At December 31, 20X0, the market price of the bonds is 93.
Required
1. Journalize Morgan Stanley’s purchase of the bonds as a long term investment on January 31, 20X0 (to be held to maturity), receipt of cash interest and amortization of the bond investment on July 31, 20X0, and accrual of interest revenue and amortization at December 31, 20X0. The straight line method is appropriate for amortizing the bond investment.
2. Show all financial statement effects of this long term bond investment on Morgan Stanley’s balance sheet and income statement at December 31, 20X0.
(Learning Objective 5: Recording foreign currency transactions and reporting the transaction gain or loss) Sun Power Drinks, Inc.(SPD) completed the following international transactions:
Apr. 4
Sold soft drink syrup on account to a Mexican company for $81,000. The exchange rate of the Mexican peso is $0.101, and the customer agrees to pay in dollars.
13
Purchased inventory on account from a Canadian company at a price of Canadian $100,000. The exchange rate of the Canadian dollar is $0.65, and payment will be in Canadian dollars.
20
Sold goods on account to an English firm for 70,000 British pounds. Payment will be in pounds, and the exchange rate of the pound is $1.96.
27
Collected from the Mexican company.
May 21
Paid the Canadian company. The exchange rate of the Canadian dollar is $0.62.
June 17
Collected from the English firm. The exchange rate of the British pound is $2.00.
Required
1. Record these transactions in Sun’s journal and show how to report the transaction gain or loss on the income statement.
2. How will what you learned in this problem help you structure international transactions? (Challenge)
(Learning Objective 5: Measuring and explaining the foreign currency translation adjustment) Amex Fabrics owns a subsidiary based in France.
Required
1. Translate the foreign currency balance sheet of the French subsidiary of Amex Fabrics into dollars. When Amex acquired this subsidiary, the euro was worth $1.17. The current exchange rate is $1.35 per euro. During the period when the subsidiary earned its income, the average exchange rate was $1.26 per euro.
Euros
Assets
3,000,000
Liabilities
1,000,000
Stockholders’ equity:
Common stock
300,000
Retained earnings
1,700,000
3,000,000
Before you perform the foreign currency translation calculation, indicate whether Amex Fabrics has experienced a positive or a negative foreign currency translation adjustment. State whether the adjustment is a gain or loss, and show where it is reported in the financial statements.
2. To which company does the translation adjustment “belong”? In which company’s financial statements will the translation adjustment be reported?
(Learning Objective 6: Using a cash flow statement) Excerpts from The Coca Cola Company statement of cash flows, as adapted, appear as follows:
The Coca Cola Company and Subsidiaries Consolidated Statements of Cash Flows (Adapted)
Years Ended December 31,
(In millions)
20X4
20X3
Operating Activities
Net cash provided by operating activities
$ 4,110
$ 1,165
Investing Activities
Purchases of property, plant, and equipment
(769)
(733)
Acquisitions and investments, principally trademarks and bottling companies
(651)
(397)
Purchases of investments
(456)
(508)
Proceeds from disposals of investments
455
290
Proceeds from disposals of property, plant, and equipment
91
45
Other investing activities
142
138
Net cash used in investing activities
(1,188)
(1,165)
Financing activities
Issuances of debt (borrowing)
3,011
3,671
Payments of debt
(3,937)
(4,256)
Issuances of stock
164
331
Purchases of stock for treasury
(277)
(133)
Dividends
(1,791)
(1,685)
Net cash used in financing activities
(2,830)
(2,072)
Required
As the chief executive officer of The Coca Cola Company, your duty is to write the management letter to your stockholders explaining Coca Cola’s major investing activities during 20X4. Compare the company’s level of investment with previous years and indicate how the company financed its investments during 20X4. Net income for 20X4 was $3,969 million.
(Learning Objective 1, 5: Making an investment decision) Infografix Corporation’s consolidated sales for 20X6 were $26.6 billion, and expenses totaled $24.8 billion. Infografix operates worldwide and conducts 37% of its business outside the United States. During 20X6, Infografix reported the following items in its financial statements (amounts in billions):
Foreign currency translation adjustments
$(202)
Unrealized holding on available for sale investments
(328)
As you consider an investment in Infografix stock, some concerns arise. Answer each of the following questions:
1. What do the parentheses around the two dollar amounts signify?
2. Are these items reported as assets, liabilities, stockholders’ equity, revenues, or expenses? Are they normal balance accounts, or are they contra accounts?
3. Are these items reason for rejoicing or sorrow at Infografix? Are Infografix’s emotions about these items deep or only moderate? Why? (Challenge)
4. Did Infografix include these items in net income? in retained earnings? In the final analysis, how much net income did Infografix report for 20X6?
5. Should these items scare you away from investing in Infografix stock? Why or why not? (Challenge)
(Learning Objective 1, 2, 4: Making an investment sale decision) Cathy Talbert is the general manager of Barham Company, which provides data management services for physicians in the Columbus, Ohio, area. Barham Company is having a rough year. Net income trails projections for the year by almost $75,000. This shortfall is especially important. Barham plans to issue stock early next year and needs to show investors that the company can meet its earnings targets. Barham holds several investments purchased a few years ago. Even though investing in stocks is outside Barham’s core business of data management services, Talbert thinks these investments may hold the key to helping the company meet its net income goal for the year. She is considering what to do with the following investments:
1. Barham owns 50% of the common stock of Ohio Office Systems, which provides the business forms that Barham uses. Ohio Office Systems has lost money for the past 2 years but still has a retained earnings balance of $550,000. Talbert thinks she can get Ohio’s treasurer to declare a $160,000 cash dividend, half of which would go to Barham.
2. Barham owns a bond investment purchased 8 years ago for $250,000. The purchase price represents a discount from the bonds’ maturity value of $400,000. These bonds mature 2 years from now, and their current market value is $380,000. Ms. Talbert has checked with a Charles Schwab investment representative, and Talbert is considering selling the bonds. Schwab would charge a 1% commission on the sale transaction.
3. Barham owns 5,000 shares of Microsoft stock valued at $53 per share. One year ago,Microsoft stock was worth only $28 per share. Barham purchased the Microsoft stock for $37 per share. Talbert wonders whether Barham should sell the Microsoft stock.
Required
Evaluate all 3 actions as a way for Barham Company to generate the needed amount of income. Recommend the best way for Barham to achieve its net income goal.
Media One owns 18% of the voting stock of Web Talk, Inc. The remainder of the Web Talk stock is held by numerous investors with small holdings. Austin Cohen, president of Media One and a member of Web Talk’s board of directors, heavily influences Web Talk’s policies. Under the market value method of accounting for investments, Media One’s net income increases as it receives dividend revenue from Web Talk. Media One pays President Cohen a bonus computed as a percentage of Media One’s net income. Therefore, Cohen can control his personal bonus to a certain extent by influencing Web Talk’s dividends. A recession occurs in 20X4, and Media One’s income is low. Cohen uses his power to have Web Talk pay a large cash dividend. The action requires Web Talk to borrow in order to pay the dividend.
Required
1. In getting Web Talk to pay the large cash dividend, is Cohen acting within his authority as a member of the Web Talk board of directors? Are Cohen’s actions ethical? Whom can his actions harm?
2. Discuss how using the equity method of accounting for investment would decrease
(Learning Objective 2, 3, 5: Analyzing investments, consolidated subsidiaries, and international operations) The financial statements of YUM! Brands, Inc. are given in Appendix A at the end of this book.
1. YUM accounts for its investments in unconsolidated affiliates by the equity method.
During 2006, YUM made additional equity method investments and sold no equity method investments. Assume YUM received no dividends from unconsolidated affiliates. What was the overall result of operations for YUM’s unconsolidated affiliates during 2006? State the reason underlying your answer.
2. What is YUM’s percentage ownership of its consolidated subsidiaries? How can you tell? Which financial statement provides the evidence?
3. Does YUM have any foreign subsidiaries? What evidence answers this question? Which financial statement provides the evidence?
4. Which monetary currency was stronger, the U.S. dollar or YUM’s foreign currencies, during 2004, 2005, and 2006? Give the basis for your answers.
(Learning Objective 3, 5: Analyzing consolidated statements and international operations) This case is based on the financial statements of Pier 1 Imports, Inc. given in Appendix B at the end of this book.
1. What indicates that Pier 1 Imports owns foreign subsidiaries? Identify the item that proves your point and the financial statement on which the item appears.
2. Which currency, the U.S. dollar, or Pier 1’s foreign currencies, was stronger in each fiscal year 2004, 2005, and 2006? Give the evidence to support each answer. Ignore the minimum pension liability adjustment.
3. At February 25, 2006, did Pier 1 Imports have a cumulative net gain or a cumulative net loss from translating its foreign subsidiaries’ financial statements into dollars? How can you tell? Ignore the beginning balance of Cumulative Other Comprehensive Income at March 1, 2003.
Pick a stock from The Wall Street Journal or other database or publication. Assume that your group purchases 1,000 shares of the stock as a long term investment and that your 1,000 shares are less than 20% of the company’s outstanding stock. Research the stock in Value Line, Moody’s Investor Record, or other source to determine whether the company pays cash dividends and, if so, how much and at what intervals.
Required
1. Track the stock for a period assigned by your professor. Over the specified period, keep a daily record of the price of the stock to see how well your investment has performed. Each day, search the Corporate Dividend News in The Wall Street Journal to keep a record of any dividends you’ve received. End the period of your analysis with a month end, such as September 30 or December 31.
2. Journalize all transactions that you have experienced, including the stock purchase, dividends received (both cash dividends and stock dividends), and any year end adjustment required by the accounting method that is appropriate for your situation. Assume you will prepare financial statements on the ending date of your study.
3. Show what you will report on your company’s balance sheet, income statement, and statement of cash flows as a result of your investment transactions.
Net Play Company, a manufacturer of tennis rackets, started production in November 2010. For the preceding 5 years Net Play had been a retailer of sports equipment. After a thorough survey of tennis racket markets, Net Play decided to turn its retail store into a tennis racket factory. Raw materials cost for a tennis racket will total $23 per racket. Workers on the production lines are paid on average $13 per hour. A racket usually takes 2 hours to complete. In addition, the rent on the equipment used to produce rackets amounts to $1,300 per month. Indirect materials cost $3 per racket. A supervisor was hired to oversee production; her monthly salary is $3,500. Janitorial costs are $1,400 monthly. Advertising costs for the rackets will be $6,000 per month. The factory building depreciation expense is $8,400 per year. Property taxes on the factory building will be $7,200 per year.
Instructions
(a) Prepare an answer sheet with the following column headings.
Product Costs
Cost
Direct
Direct
Manufacturing
Period
Item
Materials
Labor
Overhead
Costs
Assuming that Net Play manufactures, on average, 2,500 tennis rackets per month, enter each cost item on your answer sheet, placing the dollar amount per month under the appropriate headings. Total the dollar amounts in each of the columns.
Incomplete manufacturing costs, expenses, and selling data for two different cases are as follows.
A
B
Direct Materials Used
$ 6,300
$(g)
Direct Labor
3,000
4,000
Manufacturing Overhead
6,000
5,000
Total Manufacturing Costs
(a)
16,000
Beginning Work in Process Inventory
1,000
(h)
Ending Work in Process Inventory
(b)
2,000
Sales
22,500
(i)
Sales Discounts
1,500
1,200
Cost of Goods Manufactured
15,800
20,000
Beginning Finished Goods Inventory
(c)
5,000
Goods Available for Sale
18,300
(j)
Cost of Goods Sold
(d)
(k)
Ending Finished Goods Inventory
1,200
2,500
Gross Profit
(e)
6,000
Operating Expenses
2,700
(l)
Net Income
(f)
2,200
Instructions
(a) Indicate the missing amount for each letter.
(b) Prepare a condensed cost of goods manufactured schedule for Case A.
(c) Prepare an income statement and the current assets section of the balance sheet for Case A.
Assume that in Case A the other items in the current assets section are as follows: Cash $3,000, Receivables (net) $10,000, Raw Materials $700, and Prepaid Expenses $200.
(Learning Objective 7: Analyzing the statement of cash flows) The statement of cash flows of Picture Perfect Photography reported the following for the year ended December 31, 20X8.
Cash flows from financing activities:
Dividends [declared and] paid
$ (8,300)
Proceeds from issuance of common stock at par value……………
14,100
Payments of short term notes payable
(6,900)
Payments of long term notes payable
(1,300)
Proceeds from issuance of long term notes payable
2,100
Purchases of treasury stock
(6,300)
Required
Make the journal entry that Picture Perfect used to record each of these transactions.
(Learning Objective 2: Evaluating alternative ways of raising capital) Nate Smith and Darla Jones have written a computer program for a video game that may rival Playstation and Xbox. They need additional capital to market the product, and they plan to incorporate their business. Smith and Jones are considering alternative capital structures for the corporation. Their primary goal is to raise as much capital as possible without giving up control of the business. Smith and Jones plan to receive 50,000 shares of the corporation’s common stock in return for the net assets of their old business. After the old company’s books are closed and the assets adjusted to current market value, Smith’s and Jones’s capital balances will each be $25,000. The corporation’s plans for a charter include an authorization to issue 10,000 shares of preferred stock and 500,000 shares of $1 par common stock. Smith and Jones are uncertain about the most desirable features for the preferred stock. Prior to incorporating, Smith and Jones are discussing their plans with 2 investment groups. The corporation can obtain capital from outside investors under either of the following plans:
Plan 1. Group 1 will invest $80,000 to acquire 800 shares of 6%, $100 par nonvoting, preferred stock.
Plan 2. Group 2 will invest $55,000 to acquire 500 shares of $5, no par preferred stock and $35,000 to acquire 35,000 shares of common stock. Each preferred share receives 50 votes on matters that come before the stockholders.
Required
Assume that the corporation is chartered.
1. Journalize the issuance of common stock to Smith and Jones. Debit each person’s capital account for its balance.
2. Journalize the issuance of stock to the outsiders under both plans.
3. Assume that net income for the first year is $120,000 and total dividends are $30,000. Prepare the stockholders’ equity section of the corporation’s balance sheet under both plans.
4. Recommend one of the plans to Smith and Jones. Give your reasons. (Challenge)
(Learning Objective 4: Analyzing cash dividends and stock dividends) United Parcel Service (UPS), Inc. had the following stockholders’ equity amounts on December 31, 20X5 (adapted, in millions):
Common stock and additional paid in capital; 1,135 shares issued
$ 278
Retained earnings
9,457
Total stockholders’ equity
$9,735
During 20X5, UPS paid a cash dividend of $0.715 per share. Assume that, after paying the cash dividends, UPS distributed a 10% stock dividend. Assume further that the following year UPS declared and paid a cash dividend of $0.65 per share.
Suppose you own 10,000 shares of UPS common stock, acquired 3 years ago, prior to the 10% stock dividend. The market price of UPS stock was $61.02 per share before the stock dividend.
Required
1. How does the stock dividend affect your proportionate ownership in UPS? Explain.
2. What amount of cash dividends did you receive last year? What amount of cash dividends will you receive after the above dividend action?
3. Assume that immediately after the stock dividend was distributed, the market value of
UPS’s stock decreased from $61.02 per share to $55.473 per share. Does this decrease represent a loss to you? Explain. (Challenge)
4. Suppose UPS announces at the time of the stock dividend that the company will continue to pay the annual $0.715 cash dividend per share, even after distributing the stock dividend. Would you expect the market price of the stock to decrease to $55.473 per share as in Requirement 3? Explain.
(Learning Objective 2, 3, 4, 5: Evaluating financial position and profitability) At December 31, 20X4, Enron Corporation reported the following data (condensed in millions):
Total assets
$65,503
Total liabilities
54,033
Stockholders’ equity
11,470
Net income, as reported, for 20X4
979
During 20X5, Enron restated company financial statements for 20X1 to 20X4, after reporting that some data had been omitted from those prior year statements. Assume that the startling events of 20X5 included the following:
• Several related companies should have been, but were not, included in the Enron statements for 20X4. These companies had total assets of $5,700 million, liabilities totaling $5,600 million, and net losses of $130 million.
• In January 20X5, Enron’s stockholders got the company to give them $2,000 million of
12% long term notes payable in return for their giving up their common stock. Interest is accrued at year end. Take the role of a financial analyst. It is your job to analyze Enron Corporation and rate the company’s long term debt.
Required
1. Measure Enron’s expected net income for 20X5 two ways:
a. Assume 20X5’s net income should be the same as the amount of net income that
Enron actually reported for 20X4. (Given)
b. Recompute expected net income for 20X5 taking into account the new developments of 20X5. (Challenge)
c. Evaluate Enron’s likely trend of net income for the future. Discuss why this trend is developing. Ignore income tax. (Challenge)
2. Write Enron’s accounting equation two ways:
a. As actually reported at December 31, 20X4.
b. As adjusted for the events of 20X5.
3. Measure Enron’s debt ratio as reported at December 31, 20X4, and again after making the adjustments for the events of 20X5.
4. Based on your analysis, make a recommendation to the Debt Rating Committee of
Moody’s Investor Services. Would you recommend upgrading, downgrading, or leaving Enron’s debt rating undisturbed (currently, it is “high grade”). (Challenge)
Note: This case is based on a real situation. George Campbell paid $50,000 for a franchise that entitled him to market Success Associates software programs in the countries of the European Union. Campbell intended to sell individual franchises for the major language groups of western Europe—German, French, English, Spanish, and Italian. Naturally, investors considering buying a franchise from Campbell asked to see the financial statements of his business. Believing the value of the franchise to be greater than $50,000, Campbell sought to capitalize his own franchise at $500,000. The law firm of McDonald & LaDue helped Campbell form a corporation chartered to issue 500,000 shares of common stock with par value of $1 per share. Attorneys suggested the following chain of transactions:
a. A third party borrows $500,000 and purchases the franchise from Campbell.
b. Campbell pays the corporation $500,000 to acquire all its stock.
c. The corporation buys the franchise from the third party, who repays the loan. In the final analysis, the third party is debt free and out of the picture. Campbell owns all the corporation’s stock, and the corporation owns the franchise. The corporation balance sheet lists a franchise acquired at a cost of $500,000. This balance sheet is Campbell’s most valuable marketing tool.
Required
1. What is unethical about this situation?
2. Who can be harmed in this situation? How can they be harmed? What role does accounting play here?
St. Genevieve Petroleum Company is an independent oil producer in Baton Parish, Louisiana. In February, company geologists discovered a pool of oil that tripled the company’s proven reserves. Prior to disclosing the new oil to the public, St. Genevieve quietly bought most of its stock as treasury stock. After the discovery was announced, the company’s stock price increased from $6 to $27.
Required
1. Did St. Genevieve managers behave ethically? Explain your answer.
2. Identify the accounting principle relevant to this situation.
3. Who was helped and who was harmed by management’s action?
(Learning Objective 2, 3, 6: Analyzing common stock, retained earnings, return on equity, and return on assets) YUM! Brands’ financial statements appear in Appendix A at the end of this book.
1. YUM reports common stock in a single total. Why is there no paid in capital in excess of par?
2. YUM’s common stock balance appears to be 0. Does the company really have no common stock outstanding? Explain. (Challenge)
3. Examine YUM’s statement of shareholders’ equity. Explain why YUM’s retained earnings balance decreased during 2006.
4. Compute YUM’s return on equity and return on assets for 2006. Which is larger? Is this a sign of financial strength or weakness? Explain.
(Learning Objective 2, 3, 4: Analyzing treasury stock and retained earnings) This case is based on the financial statements of Pier 1 Imports, given in Appendix B at the end of this book. In particular, this case uses Pier 1’s statement of shareholders’ equity for the year 2006.
1. During 2006, Pier 1 purchased treasury stock and also sold treasury stock under the company’s stock option plan and stock purchase plan. Was Pier 1’s average price per share higher for the treasury stock the company purchased or for the treasury stock sold under the stock option plan and the stock purchase plan? What was the difference in price per share between the 2 transactions? Ignore the “Restricted stock grant and amortization.”
2. Journalize the purchase of treasury stock and the sale of treasury stock under the stock option plan and the stock purchase plan during the year ended February 25, 2006.
3. Prepare a T account to show the beginning and ending balances, plus all the activity in Retained Earnings for the year ended February 25, 2006.
Competitive pressures are the norm in business. Lexus automobiles (made in Japan) have cut into the sales of Mercedes Benz (a German company), Jaguar Motors (a British company), General Motors Cadillac Division, and Ford Lincoln Division (both U.S. companies). Dell, Gateway, and Compaq computers have siphoned business away from Apple and IBM. Foreign steelmakers have reduced the once massive U.S. steel industry to a fraction of its former size. Indeed, corporate downsizing has occurred on a massive scale. Each company or industry mentioned here has pared down plant and equipment, laid off employees, or restructured operations.
Required
1. Identify all the stakeholders of a corporation. A stakeholder is a person or a group who has an interest (that is, a stake) in the success of the organization.
2. Identify several measures by which a company may be considered deficient and in need of downsizing. How can downsizing help to solve this problem?
3. Debate the downsizing issue. One group of students takes the perspective of the company and its stockholders, and another group of students takes the perspective of the other stakeholders of the company (the community in which the company operates and society at large).
1. Identify the appropriate accounting method for each of the following situations:
a. Investment in 25% of investee’s stock
b. 10% investment in stock
c. Investment in more than 50% of investee’s stock
2. At what amount should the following available for sale investment portfolio be reported on the December 31 balance sheet? All the investments are less than 5% of the investee’s stock.
Stock
Investment Cost
Current Market Value
DuPont
$ 5,000
$ 5,500
ExxonMobil
61,200
53,000
Procter & Gamble
3,680
6,230
Journalize any adjusting entry required by these data.
3. Investor paid $67,900 to acquire a 40% equity method investment in the common stock of Investee. At the end of the first year, Investee’s net income was $80,000, and
Investee declared and paid cash dividends of $55,000. What is Investor’s ending balance in its Equity Method Investment account? Use a T account to answer.
4. Parent company paid $85,000 for all the common stock of Subsidiary Company, and Parent owes Subsidiary $20,000 on a note payable. Complete the consolidation work sheet below.
Translate the balance sheet of the Brazilian subsidiary of Wrangler Corporation, a U.S. company, into dollars. When Wrangler acquired this subsidiary, the exchange rate of the Brazilian currency, the real, was $0.40. The average exchange rate applicable to retained earnings is $0.41. The real’s current exchange rate is $0.43. Before performing the translation, predict whether the translation adjustment will be positive or negative. Does this situation generate a foreign currency translation gain or loss? Give your reasons.
(Learning Objective 1: Accounting for an available for sale investment; unrealized gain or loss) Assume UPS completed these long term available for sale investment transactions during 20X7:
20X7
Apr. 10
Purchased 300 shares of Sysco stock, paying $20 per share. UPS intends to hold the investment for the indefinite future.
July 22
Received a cash dividend of $1.25 per share on the Sysco stock.
Dec. 31
Adjusted the Sysco investment to its current market value of $5,100.
1. Journalize UPS’s investment transactions. Explanations are not required.
2. Show how to report the investment and any unrealized gain or loss on UPS’s balance sheet at December 31, 20X8. Ignore income tax.
(Learning Objective 5: Managing and accounting for foreign currency transactions) Assume that Circuit City Stores completed the following foreign currency transactions:
Mar. 17
Purchased DVD players as inventory on account from Sony. The price was 300,000 yen, and the exchange rate of the yen was $0.0086.
Apr. 16
Paid Sony when the exchange rate was $0.0082.
19
Sold merchandise on account to BonTemps, a French company, at a price of 60,000 euros. The exchange rate was $1.20
30
Collected from BonTemps when the exchange rate was $1.15.
1. Journalize these transactions for Circuit City. Focus on the gains and losses caused by changes in foreign currency rates.
2. On March 18, immediately after the purchase, and on April 20, immediately after the sale, which currencies did Circuit City want to strengthen? Which currencies did in fact streng then? Explain your reasoning in detail.
(Learning Objective 5: Translating a foreign currency balance sheet into dollars) Translate into dollars the balance sheet of California Leather Goods’ Spanish subsidiary. When California Leather Goods acquired the foreign subsidiary, a euro was worth $1.01. The current exchange rate is $1.35. During the period when retained earnings were earned, the average exchange rate was $1.15 per euro
Euros
Assets
500,000
Liabilities
300,000
Stockholders’ equity:
Common stock
50,000
Retained earnings
150,000
500,000
During the period covered by this situation, which currency was stronger, the dollar or the euro?
(Learning Objective 6: Using the statement of cash flows) At the end of the year, Blue Chip Properties’ statement of cash flows reported the following for investment activities:
Blue Chip Properties Consolidated Statement of Cash Flows (Partial)
Cash flows from Investing Activities
Notes receivable collected
$ 3,110,000
Purchases of short term investments
(3,457,000)
Proceeds from sales of equipment
1,409,000
Proceeds from sales of investments (cost of $450,000)
461,000
Expenditures for property and equipment
(1,761,000)
Net cash used by investing activities
$ (238,000)
Required
For each item listed, make the journal entry that placed the item on Blue Chip’s statement of cash flows.
(Learning Objective 1, 2, 3, 5: Accounting for various types of investments) This exercise summarizes the accounting for investments. Suppose YouTube.com owns the following investments at December 31, 20X1:
a. 100% of the common stock of YouTube United Kingdom, which holds assets of
£800,000 and owes a total of £600,000. At December 31, 20X1, the current exchange rate of the pound (£) is £1 = $2.00. The translation rate of the pound applicable to stockholders’ equity is £1 = $1.60. During 20X1, YouTube United Kingdom earned net income of £100,000 and the average exchange rate for the year was £1 = $1.95. YouTube United Kingdom paid cash dividends of £40,000 during 20X1.
b. Investments that YouTube is holding to sell. These investments cost $900,000 and declined in value by $400,000 during 20X1, but they paid cash dividends of $16,000 to YouTube. One year ago, at December 31, 20X0, the market value of these investments was $1,100,000.
c. 25% of the common stock of YouTube Financing Associates. During 20X1, YouTube Financing earned net income of $300,000 and declared and paid cash dividends of $80,000. The carrying amount of this investment was $700,000 at December 31, 20X0.
Required
1. Which method is used to account for each investment?
2. By how much did each of these investments increase or decrease YouTube’s net income during 20X1?
3. For investments b and c, show how YouTube would report these investments on its balance sheet at December 31, 20X1.
(Learning Objective 1, 6: Explaining and analyzing accumulated other comprehensive income) Big Box Retail Corporation reported stockholders’ equity on its balance sheet at December 31, as follows:
Big Box Retail Balance Sheet (Partial)
Shareholders’ Equity:
Millions
Common stock, $0.10 par value— 800 million shares authorized, 300 million shares issued
$ 30
Additional paid in capital
1,088
Retained earnings
6,250
Accumulated other comprehensive (loss)
(?)
Less Treasury stock, at cost
(50)
Required
1. Identify the 2 components that typically make up Accumulated other comprehensive income.
2. For each component of Accumulated other comprehensive income, describe the event that can cause a positive balance. Also describe the events that can cause a negative balance for each component.
3. At December 31, 20X2, Big Box’s Accumulated other comprehensive loss was $53 million. Then during 20X3, Big Box had a positive foreign currency translation adjustment of $29 million and an unrealized loss of $16 million on available for sale investments. What was Big Box’s balance of Accumulated other comprehensive income (loss) at December 31, 20X3?
(Learning Objective 1, 2: Reporting investments on the balance sheet and the related revenue on the income statement) Washington Exchange Company completed the following long term investment transactions during 20X6:
20X6
May 12
Purchased 20,000 shares, which make up 35% of the common stock of Fellingham Corporation at total cost of $370,000.
July 9
Received annual cash dividend of $1.26 per share on the Fellingham investment.
Sept. 16
Purchased 800 shares of Tomassini, Inc., common stock as an available for sale investment, paying $41.50 per share.
Oct. 30
Received cash dividend of $0.30 per share on the Tomassini investment.
Dec. 31
Received annual report from Fellingham Corporation. Net income for the year was $510,000.
At year end the current market value of the Tomassini stock is $30,600. The market value of the Fellingham stock is $652,000.
Required
1. For which investment is current market value used in the accounting? Why is market value used for 1 investment and not the other?
2. Show what Washington would report on its year end balance sheet and income statement for these investment transactions. It is helpful to use a T account for the Long Term Investment in Fellingham Stock account. Ignore income tax.
Sota Company is a manufacturer of personal computers.Various costs and expenses associated with its operations are as follows.
1. Property taxes on the factory building.
2. Production superintendents’ salaries.
3. Memory boards and chips used in assembling computers.
4. Depreciation on the factory equipment.
5. Salaries for assembly line quality control inspectors.
6. Sales commissions paid to sell personal computers.
7. Electrical components used in assembling computers.
8. Wages of workers assembling personal computers.
9. Soldering materials used on factory assembly lines.
10. Salaries for the night security guards for the factory building.
The company intends to classify these costs and expenses into the following categories: (a) direct materials, (b) direct labor, (c) manufacturing overhead, and (d) period costs.
Instructions
List the items (1) through (10). For each item, indicate the cost category to which it belongs.
The administrators of San Diego County’s Memorial Hospital are interested in identifying the various costs and expenses that are incurred in producing a patient’s X ray. A list of such costs and expenses in presented below.
1. Salaries for the X ray machine technicians.
2. Wages for the hospital janitorial personnel.
3. Film costs for the X ray machines.
4. Property taxes on the hospital building.
5. Salary of the X ray technicians’ supervisor.
6. Electricity costs for the X ray department.
7. Maintenance and repairs on the X ray machines.
8. X ray department supplies.
9. Depreciation on the X ray department equipment.
10. Depreciation on the hospital building.
The administrators want these costs and expenses classified as: (a) direct materials, (b) direct labor, or (c) service overhead.
Instructions
List the items (1) through (10). For each item, indicate the cost category to which the item belongs.
Coldplay Corporation incurred the following costs while manufacturing its product.
Materials used in product
$100,000
Advertising expense
$45,000
Depreciation on plant
60,000
Property taxes on plant
14,000
Property taxes on store
7,500
Delivery expense
21,000
Labor costs of assembly line workers
110,000
Sales commissions
35,000
Factory supplies used
23,000
Salaries paid to sales clerks
50,000
Work in process inventory was $12,000 at January 1 and $15,500 at December 31. Finished goods inventory was $60,000 at January 1 and $55,600 at December 31.
Sara Collier, the bookkeeper for Danner, Cheney, and Howe, a political consulting firm, has recently completed an accounting course at her local college. One of the topics covered in the course was the cost of goods manufactured schedule. Sara wondered if such a schedule could be prepared for her firm. She realized that, as a service oriented company, it would have no Work in Process inventory to consider.
Listed below are the costs her firm incurred for the month ended August 31, 2010.
Supplies used on consulting contracts
$ 1,200
Supplies used in the administrative offices
1,500
Depreciation on equipment used for contract work
900
Depreciation used on administrative office equipment
1,050
Salaries of professionals working on contracts
12,600
Salaries of administrative office personnel
7,700
Janitorial services for professional offices
400
Janitorial services for administrative offices
500
Insurance on contract operations
800
Insurance on administrative operations
900
Utilities for contract operations
1,400
Utilities for administrative offices
1,300
Instructions
(a) Prepare a schedule of cost of contract services provided (similar to a cost of goods manufactured schedule) for the month.
(b) For those costs not included in (a), explain how they would be classified and reported in the financial statements.
Corbin Manufacturing Company produces blankets. From its accounting records it prepares the following schedule and financial statements on a yearly basis.
(a) Cost of goods manufactured schedule.
(b) Income statement.
(c) Balance sheet.
The following items are found in its ledger and accompanying data.
1. Direct labor
9. Factory maintenance salaries
2. Raw materials inventory, 1/1
10. Cost of goods manufactured
3. Work in process inventory, 12/31
11. Depreciation on delivery equipment
4. Finished goods inventory, 1/1
12. Cost of goods available for sale
5. Indirect labor
13. Direct materials used
6. Depreciation on factory machinery
14. Heat and electricity for factory
7. Work in process, 1/1
15. Repairs to roof of factory building
8. Finished goods inventory, 12/31
16. Cost of raw materials purchases
Instructions
List the items (1)–(16). For each item, indicate by using the appropriate letter or letters, the schedule and/or financial statement(s) in which the item will appear.
An analysis of the accounts of Chamberlin Manufacturing reveals the following manufacturing cost data for the month ended June 30, 2010.
Inventories
Beginning
Ending
Raw materials
$9,000
$13,100
Work in process
5,000
7,000
Finished goods
9,000
6,000
Costs incurred: Raw materials purchases $54,000, direct labor $57,000, manufacturing overhead $19,900. The specific overhead costs were: indirect labor $5,500, factory insurance $4,000, machinery depreciation $4,000, machinery repairs $1,800, factory utilities $3,100, miscellaneous factory costs $1,500. Assume that all raw materials used were direct materials.
Instructions
(a) Prepare the cost of goods manufactured schedule for the month ended June 30, 2010.
(b) Show the presentation of the ending inventories on the June 30, 2010, balance sheet.
Todd Motor Company manufactures automobiles. During September 2010 the company purchased 5,000 head lamps at a cost of $9 per lamp.Todd withdrew 4,650 lamps from the warehouse during the month. Fifty of these lamps were used to replace the head lamps in autos used by traveling sales staff.The remaining 4,600 lamps were put in autos manufactured during the month. Of the autos put into production during September 2010, 90% were completed and transferred to the company’s storage lot. Of the cars completed during the month, 75% were sold by September 30.
Instructions
(a) Determine the cost of head lamps that would appear in each of the following accounts at September 30, 2010: Raw Materials,Work in Process, Finished Goods, Cost of Goods Sold, and Selling Expenses.
(b) Write a short memo to the chief accountant, indicating whether and where each of the accounts in (a) would appear on the income statement or on the balance sheet at
The following is a list of terms related to managerial accounting practices.
1. Activity based costing.
2. Just in time inventory.
3. Balanced scorecard.
4. Value chain.
Instructions
Match each of the terms with the statement below that best describes the term.
(a) ____ A performance measurement technique that attempts to consider and evaluate all aspects of performance using financial and nonfinancial measures in an integrated fashion.
(b) ____ The group of activities associated with providing a product or service.\
(c) ____ An approach used to reduce the cost associated with handling and holding inventory by reducing the amount of inventory on hand.
(d) ____ A method used to allocate overhead to products based on each product’s use of the activities that cause the incurrence of the overhead cost.
Incomplete manufacturing costs, expenses, and selling data for two different cases are as follows.
Case
1
2
Direct Materials Used
7,600
$(G)
Direct Labor
5,000
8,000
Manufacturing Overhead
8,000
4,000
Total Manufacturing Costs
(a)
18,000
Beginning Work in Process Inventory
1,000
(h)
Ending Work in Process Inventory
(b)
3,000
Sales
24,500
(i)
Sales Discounts
2,500
1,400
Cost of Goods Manufactured
17,000
22,000
Beginning Finished Goods Inventory
(c)
3,300
Goods Available for Sale
18,000
(j)
Cost of Goods Sold
(d)
(k)
Ending Finished Goods Inventory
3,400
2,500
Gross Profit
(e)
7,000
Operating Expenses
2,500
(l)
Net Income
(f)
5,000
Instructions
(a) Indicate the missing amount for each letter.
(b) Prepare a condensed cost of goods manufactured schedule for Case 1.
(c) Prepare an income statement and the current assets section of the balance sheet for Case 1. Assume that in Case 1 the other items in the current assets section are as follows: Cash $4,000, Receivables (net) $15,000, Raw Materials $600, and Prepaid Expenses $400.
Petra Company specializes in manufacturing motorcycle helmets. The company has enough orders to keep the factory production at 1,000 motorcycle helmets per month. Petra’s monthly manufacturing cost and other expense data are as follows.
Maintenance costs on factory building
$ 1,500
Factory manager’s salary
4,000
Advertising for helmets
8,000
Sales commissions
5,000
Depreciation on factory building
700
Rent on factory equipment
6,000
Insurance on factory building
3,000
Raw materials (plastic, polystyrene, etc.)
20,000
Utility costs for factory
800
Supplies for general office
200
Wages for assembly line workers
54,000
Depreciation on office equipment
500
Miscellaneous materials (glue, thread, etc.)
2,000
Instructions
(a) Prepare an answer sheet with the following column headings.
Product Costs
Cost
Direct
Direct
Manufacturing
Period
Item
Materials
Labor
Overhead
Costs
Enter each cost item on your answer sheet, placing the dollar amount under the appropriate headings.Total the dollar amounts in each of the columns.
(b) Compute the cost to produce one motorcycle helmet.
You are provided with the following transactions that took place during a recent fiscal year.
Transaction
Where Reported on Statement
Cash Inflow, Outflow, or No Effect?
(a) Recorded depreciation expense on the plant assets.
(b) Incurred a loss on disposal of plant assets.
(c) Acquired a building by paying cash.
(d) Made principal repayments on a mortgage.
(e) Issued common stock.
(f) Purchased shares of another company to be held as a long term equity investment.
(g) Paid dividends to common stockholders.
(h) Sold inventory on credit. The company uses a perpetual inventory system.
(i) Purchased inventory on credit.
(j) Paid wages to employees.
Instructions
Complete the table indicating whether each item (1) should be reported as an operating (O) activity, investing (I) activity, financing (F) activity, or as a noncash (NC) transaction reported in a separate schedule, and (2) represents a cash inflow or cash outflow or has no cash flow effect. Assume use of the indirect approach.
The income statement of Rosenthal Company is presented below.
Additional information:
1. Accounts receivable decreased $320,000 during the year, and inventory increased $120,000.
2. Prepaid expenses increased $175,000 during the year.
3. Accounts payable to merchandise suppliers increased $50,000 during the year.
4. Accrued expenses payable increased $155,000 during the year.
ROSENTHAL COMPANY Income Statement For the Year Ended December 31, 2010
Sales
$5,400,000
Cost of goods sold
Beginning inventory
$1,780,000
Purchases
3,430,000
Goods available for sale
5,210,000
Ending inventory
1,900,000
Total cost of goods sold
3,310,000
Gross profit
2,090,000
Operating expenses
Depreciation expense
105,000
Amortization expense
20,000
Other expenses
945,000
1,070,000
Net income
$1,020,000
Instructions
Prepare the operating activities section of the statement of cash flows for the year ended December 31, 2010, for Rosenthal Company, using the indirect method.
Ron Nord and Lisa Smith are examining the following statement of cash flows for Carpino Company for the year ended January 31, 2010.
CARPINO COMPANY Statement of Cash Flows For the Year Ended January 31, 2010
Sources of cash
From sales of merchandise
$380,000
From sale of capital stock
420,000
From sale of investment (purchased below)
80,000
From depreciation
55,000
From issuance of note for truck
20,000
From interest on investments
6,000
Total sources of cash
961,000
Uses of cash
For purchase of fixtures and equipment
330,000
For merchandise purchased for resale
258,000
For operating expenses (including depreciation)
160,000
For purchase of investment
75,000
For purchase of truck by issuance of note
20,000
For purchase of treasury stock
10,000
For interest on note payable
3,000
Total uses of cash
856,000
Net increase in cash
$ 105,000
Ron claims that Carpino’s statement of cash flows is an excellent portrayal of a superb first year with cash increasing $105,000. Lisa replies that it was not a superb first year. Rather, she says, the year was an operating failure, that the statement is presented incorrectly, and that $105,000 is not the actual increase in cash. The cash balance at the beginning of the year was $140,000.
Instructions
With the class divided into groups, answer the following.
(a) Using the data provided, prepare a statement of cash flows in proper form using the indirect method. The only noncash items in the income statement are depreciation and the gain from the sale of the investment.
(b) With whom do you agree, Ron or Lisa? Explain your position.
Tappit Corp. is a medium sized wholesaler of automotive parts. It has 10 stockholders who have been paid a total of $1 million in cash dividends for 8 consecutive years. The board’s policy requires that, for this dividend to be declared, net cash provided by operating activities as reported in Tappit’s current year’s statement of cash flows must exceed $1 million.
President and CEO Willie Morton’s job is secure so long as he produces annual operating cash flows to support the usual dividend.
At the end of the current year, controller Robert Jennings presents president Willie Morton with some disappointing news: The net cash provided by operating activities is calculated by the indirect method to be only $970,000. The president says to Robert, “We must get that amount above $1 million. Isn’t there some way to increase operating cash flow by another $30,000?” Robert answers, “These figures were prepared by my assistant. I’ll go back to my office and see what I can do.” The president replies, “I know you won’t let me down, Robert.” Upon close scrutiny of the statement of cash flows, Robert concludes that he can get the operating cash flows above $1 million by reclassifying a $60,000, 2 year note payable listed in the financing activities section as “Proceeds from bank loan—$60,000.” He will report the note instead as “Increase in payables—$60,000” and treat it as an adjustment of net income in the operating activities section. He returns to the president, saying, “You can tell the board to declare their usual dividend. Our net cash flow provided by operating activities is $1,030,000.” “Good man, Robert! I knew I could count on you,” exults the president.
Instructions
(a) Who are the stakeholders in this situation?
(b) Was there anything unethical about the president’s actions? Was there anything unethical about the controller’s actions?
(c) Are the board members or anyone else likely to discover the misclassification?
Giant Manufacturing Co. specializes in manufacturing different models of bicycles. Assume that the market has responded enthusiastically to a new model, the Jaguar.As a result, the company has established a separate manufacturing facility to produce these bicycles. The company produces 1,000 of these bicycles per month. Giant’s monthly manufacturing cost and other expenses data related to these bicycles are as follows.
1. Rent on manufacturing equipment (lease cost)
$2,000/month
2. Insurance on manufacturing building
$750/month
3. Raw materials (frames, tires, etc.)
$80/bicycle
4. Utility costs for manufacturing facility
$1,000/month
5. Supplies for administrative office
$800/month
6.Wages for assembly line workers in manufacturing facility
Superior Manufacturing Company has the following cost and expense data for the year ending December 31, 2010.
Raw materials, 1/1/10
$ 30,000
Insurance, factory
$ 14,000
Raw materials, 12/31/10
20,000
Property taxes, factory building
6,000
Raw materials purchases
205,000
Sales (net)
1,500,000
Indirect materials
15,000
Delivery expenses
100,000
Work in process, 1/1/10
80,000
Sales commissions
150,000
Work in process, 12/31/10
50,000
Indirect labor
90,000
Finished goods, 1/1/10
110,000
Factory machinery rent
40,000
Finished goods, 12/31/10
120,000
Factory utilities
65,000
Direct labor
350,000
Depreciation, factory building
24,000
Factory manager’s salary
35,000
Administrative expenses
300,000
Instructions
(a) Prepare a cost of goods manufactured schedule for Superior Company for 2010.
(b) Prepare an income statement for Superior Company for 2010.
(c) Assume that Superior Company’s ledgers show the balances of the following current asset accounts: Cash $17,000, Accounts Receivable (net) $120,000, Prepaid Expenses $13,000, and Short term Investments $26,000. Prepare the current assets section of the balance sheet for Superior Company as of December 31, 2010.
Indicate whether the following statements are true or false.
1. Managerial accountants explain and report manufacturing and nonmanufacturing costs, determine cost behaviors, and perform C V P analysis, but are not involved in the budget process.
2. Financial accounting reports pertain to subunits of the business and are very detailed.
3. Managerial accounting reports must follow GAAP and are audited by CPAs.
4. Managers’ activities and responsibilities can be classified into three broad functions: planning, directing, and controlling.
5. As a result of the Sarbanes Oxley Act of 2002 (SOX), top managers must certify that the company maintains an adequate system of internal control.
6. Management accountants follow a code of ethics developed by the Institute of Management Accountants.
Classify each cost as a period or a product cost.Within the product cost category, indicate if the cost is part of direct materials (DM), direct labor (DL), or manufacturing overhead (MO).
Excel in Action Accounting information is provided below for The Book Wermz and two of its competitors for the fiscal year ending December 31, 2005.
The Book Wermz
Book Farm
Special Editions
Sales
$6,230,000
$20,584,000
$4,896,200
Cost of goods sold
3,426,500
13,390,200
2,153,100
Operating expense
2,155,000
5,212,600
1,852,000
Interest expense
190,000
670,500
106,000
Inventory
1,987,600
5,845,000
2,246,000
Total assets
5,623,000
13,254,000
6,895,000
Stockholders’ equity
3,370,000
6,687,000
4,826,000
Required Enter the data in a spreadsheet. Use the data to prepare an income statement for each company to include gross profit, operating income, pretax income, and net income. The income tax rate for each company is 35% of pretax income. Use formulas for computed values so that changes in any of the numbers shown above will be recomputed automatically in the spreadsheet. Format the income statement appropriately. Following the income statement, enter the balance sheet data for each company. Use the income statement and balance sheet data to calculate the following ratios, which should follow the balance sheet data: gross profit margin, operating profit margin, profit margin, inventory turnover, asset turnover, return on assets, financial leverage (assets/ equity), and return on equity. The calculations should use cell references to the income statement and balance sheet data. Each ratio should include four digits to the right of the decimal.
Following the ratios, provide a brief response to the following questions.
1. Which company appears to be using a cost leadership strategy most effectively?
2. Which company appears to be using a product differentiation strategy most effectively?
3. What strategy does The Book Wermz appear to be following and how effective has this strategy been?
4. What effect has financial leverage had on the companies’ ratios?
Format each response so that it appears as wrapped text in a cell that is the width of the columns used to enter data in the spreadsheet.
Include the following captions at the top of the spreadsheet: “Financial Analysis Comparison”, followed by “December 31, 2005”. Captions should be centered over the spreadsheet columns in which accounting information appears.
Analysis of Operating Activities Appendix B of this book contains a copy of the 2002 annual report of General Mills, Inc.
Required Review the annual report and answer each question or follow the directions given.
A. Compute profit margin, asset turnover, and return on assets for the company for 2000 to 2002. Evaluate the changes you see in these measures over the three years. (Hint: See also the six year financial summary shown in the annual report for the data necessary to make some of your calculations.)
B. Compare your ratio calculations with those in Exhibit 4. Based on this and any other evidence contained in the annual report, does it appear that General Mills is using a cost leadership strategy or a product differentiation strategy?
C. Compute receivables turnover, inventory turnover, and gross profit margin for 2002 and 2001. Evaluate any changes you find.
D. Compute the return on equity for each of the three years and compare it with the return on assets. Do the changes in return on equity result more from changes in net income or from changes in the amount of stockholders’ equity?
E. Financial statements present only a partial, highly summarized view of a company. Assume that you are considering investing in General Mills’ common stock. List several items that are contained in the statements but are based on estimates. Also list several items you would like to know about the company that are not revealed in this annual report.
Analysis of an Investment You are an investment analyst. Some of your clients have talked with you about an investment they are considering in a new company, Beach Front Resorts. This company will construct condominiums and rent them to tourists. The total investment required for the project is $5.5 million. Individual investors are expected to invest not less than $100,000 each. They could borrow up to this amount at 10% annual interest. The development will contain 50 units that will cost $80,000 per unit to construct. Land for the development will cost $250,000, and $300,000 will be held in reserve for first year operating costs for the year beginning January 1, 2004. The remaining investment capital will be used for furnishings, streets, parking lots, sidewalks, and landscaping. Buildings will be depreciated over a 20 year period. Other depreciable assets will be depreciated over five years. Straight line depreciation will be used. Based on an analysis of similar developments in the area, units should rent for an average of $1,300 per week. Each unit should rent for at least 25 weeks per year. On the average, each unit is expected to rent for 30 weeks per year. Maintenance and operating costs are expected to average $200 per unit week for 52 weeks. Management costs will be $250,000 per year. A reserve fund will be established with annual reinvestments of profits of $200,000 for future repair and replacement of property. The remaining profits will be distributed to investors in proportion to their investments. The company is not subject to income tax.
Required
A. Calculate the net income and cash flow to investors from operating activities expected from the project in 2004, assuming average rentals of 25 and 30 weeks. Assume that cash flows are equivalent to revenues and expenses except for depreciation. Which is more relevant to the investment decision, net income or cash flow? Why?
B. Assume that investors could expect to receive net cash flows from their investments for 10 years at the amounts expected for 2004. At the end of 10 years, they expect to be able to sell their investments for $1.2 million. What is the present value of the cash flows, assuming 25 week and 30 week average rentals each year? The expected rate of return is 10%.
C. What effect does the company’s operating leverage have on its expected operating results?
D. Would you recommend that your clients invest in Beach Front Resorts? What factors are important to this decision other than those considered above?
JMB Photography reported net income of $100,000 for 2010. Included in the income statement were depreciation expense of $6,000, patent amortization expense of $2,000, and a gain on sale of equipment of $3,600. JMB’s comparative balance sheets show the following balances.
GRINDERS CORPORATION Statement of Cash Flows—Indirect Method For the Year Ended December 31, 2010
Cash flows from operating activities
Net income
$59,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense
$9,100
Decrease in accounts receivable
9,500
Loss on sale of equipment
3,300
Increase in inventory
(5,000)
Decrease in accounts payable
(2,200)
14,700
Net cash provided by operating activities
73,700
Cash flows from investing activities
Sale of investments
3,100
Purchase of equipment
(27,000)
Net cash used by investing activities
(23,900)
Cash flows from financing activities
Issuance of stock 20,000
Payment on long term note payable
(10,000)
Payment for dividends
(15,000)
Net cash used by financing activities
(5,000)
Net increase in cash
44,800
Cash at beginning of year
13,000
Cash at end of year
$57,800
(a) Compute free cash flow for Grinders Corporation. (b) Explain why free cash flow often provides better information than “Net cash provided by operating activities.
Pioneer Corporation had these transactions during 2010.
(a) Issued $50,000 par value common stock for cash.
(b) Purchased a machine for $30,000, giving a long term note in exchange.
(c) Issued $200,000 par value common stock upon conversion of bonds having a face value of $200,000.
(d) Declared and paid a cash dividend of $18,000.
(e) Sold a long term investment with a cost of $15,000 for $15,000 cash.
(f) Collected $16,000 of accounts receivable.
(g) Paid $18,000 on accounts payable.
Instructions
Analyze the transactions and indicate whether each transaction resulted in a cash flow from operating activities, investing activities, financing activities, or noncash investing and financing activities.
The current sections of Bellinham Inc.’s balance sheets at December 31, 2009 and 2010, are presented here.
Bellinham’s net income for 2010 was $153,000. Depreciation expense was $24,000.
2010
2009
Current assets
Cash
$105,000
$ 99,000
Accounts receivable
110,000
89,000
Inventory
158,000
172,000
Prepaid expenses
27,000
22,000
Total current assets
$400,000
$382,000
Current liabilities
Accrued expenses payable
$ 15,000
$ 5,000
Accounts payable
85,000
92,000
Total current liabilities
$100,000
$ 97,000
Instructions
Prepare the net cash provided by operating activities section of the company’s statement of cash flows for the year ended December 31, 2010, using the indirect method.
The three accounts shown below appear in the general ledger of Cesar Corp. during 2010.
Date
Debit
Credit
Balance
Jan. 1
Balance
160,000
July 31
Purchase of equipment
70,000
230,000
Sept. 2
Cost of equipment constructed
53,000
283,000
Nov. 10
Cost of equipment sold
49,000
234,000
Accumulated Depreciation—Equipment
Date
Debit
Credit
Balance
Jan. 1
Balance
71,000
Nov. 10
Accumulated depreciation on equipment sold
30,000
41,000
Dec. 31
Depreciation for year
28,000
69,000
Retained Earnings
Date
Debit
Credit
Balance
Jan. 1
Balance
105,000
Aug. 23
Dividends (cash)
14,000
91,000
Dec. 31
Net income
67,000
158,000
Instructions
From the postings in the accounts, indicate how the information is reported on a statement of cash flows using the indirect method.The loss on sale of equipment was $5,000. (Hint: Cost of equipment constructed is reported in the investing activities section as a decrease in cash of $53,000.)
Scully Corporation’s comparative balance sheets are presented below.
SCULLY CORPORATION Comparative Balance Sheets December 31
2010
2009
Cash
$ 14,300
$ 10,700
Accounts receivable
21,200
23,400
Land
20,000
26,000
Building
70,000
70,000
Accumulated depreciation
(15,000)
(10,000)
Total
$110,500
$120,100
Accounts payable
$12,370
$31,100
Common stock
75,000
69,000
Retained earnings
23,130
20,000
Total
$110,500
$120,100
Additional information:
1. Net income was $22,630. Dividends declared and paid were $19,500.
2. All other changes in noncurrent account balances had a direct effect on cash flows, except the change in accumulated depreciation. The land was sold for $4,900.
Instructions
(a) Prepare a statement of cash flows for 2010 using the indirect method.
The following account balances relate to the stockholders’ equity accounts of Gore Corp. at year end.
2010
2009
Common stock, 10,500 and 10,000 shares,
respectively, for 2010 and 2009
$160,000
$140,000
Preferred stock, 5,000 shares
125,000
125,000
Retained earnings
300,000
260,000
A small stock dividend was declared and issued in 2010. The market value of the shares was $10,500. Cash dividends were $15,000 in both 2010 and 2009. The common stock has no par or stated value.
Instructions
(a) What was the amount of net income reported by Gore Corp. in 2010?
(b) Determine the amounts of any cash inflows or outflows related to the common stock and dividend accounts in 2010.
(c) Indicate where each of the cash inflows or outflows identified in (b) would be classified on the statement of cash flows.
The income statement of Elbert Company is presented here.
ELBERT COMPANY Income Statement For the Year Ended November 30, 2010
Sales
$7,700,000
Cost of goods sold
Beginning inventory
$1,900,000
Purchases
4,400,000
Goods available for sale
6,300,000
Ending inventory
1,400,000
Total cost of goods sold
4,900,000
Gross profit
2,800,000
Operating expenses
1,150,000
Net income
$1,650,000
Additional information:
1. Accounts receivable increased $250,000 during the year, and inventory decreased $500,000.
2. Prepaid expenses increased $150,000 during the year.
3. Accounts payable to suppliers of merchandise decreased $340,000 during the year.
4. Accrued expenses payable decreased $100,000 during the year.
5. Operating expenses include depreciation expense of $90,000.
Instructions
Prepare the operating activities section of the statement of cash flows for the year ended November 30, 2010, for Elbert Company, using the indirect method.
Condensed financial data of Oprah Company appear below.
OPRAH COMPANY Comparative Balance Sheets December 31
Assets
2010
2009
Cash
$ 92,700
$ 47,250
Accounts receivable
90,800
57,000
Inventories
121,900
102,650
Investments
84,500
87,000
Plant assets
250,000
205,000
Accumulated depreciation
(49,500)
(40,000)
Liabilities and Stockholders’ Equity
$590,400
$458,900
Accounts payable
$ 57,700
$ 48,280
Accrued expenses payable
12,100
18,830
Bonds payable
100,000
70,000
Common stock
250,000
200,000
Retained earnings
170,600
121,790
$590,400
$458,900
OPRAH COMPANY Income Statement For the Year Ended December 31, 2010
Sales
$297,500
Gain on sale of plant assets
8,750
Less:
306,250
Cost of goods sold
$99,460
Operating expenses (excluding
depreciation expense)
14,670
Depreciation expense
49,700
Income taxes
7,270
Interest expense
2,940
174,040
Net income
$132,210
Additional information:
1. New plant assets costing $92,000 were purchased for cash during the year.
2. Investments were sold at cost.
3. Plant assets costing $47,000 were sold for $15,550, resulting in gain of $8,750.
4. A cash dividend of $83,400 was declared and paid during the year.
Instructions
Prepare a worksheet for the statement of cash flows using the indirect method. Enter the reconciling items directly in the worksheet columns, using letters to cross reference each entry.
Your assistant has just provided you with your company’s latest financial results. Unfortunately, several of the numbers are smudged and unreadable. They are each represented below by a letter.
Balance sheet (as of month end)
Income statement (as of month end)
Cash
$482
Sales revenue
$10,377
Accounts receivable
(a)
Cost of goods sold
6,226
Merchandise inventory
(b)
Gross profit
(f)
Buildings and equipment
$3,411
Operating expenses:
Accumulated depreciation
922
Advertising
$350
Investments, long term
250
Depreciation
500
Land
980
Rent
(g)
Total assets
$ (c)
Wages
376
(h)
Income before taxes
$1,945
Accounts payable
$977
Income taxes (35%)
(i)
Notes payable, long term
(d)
Net income
$ (j)
Common stock
3,400
Retained earnings
1,491
Total liabilities and equity
$ (e)
Summary ratio values
1. Accounts receivable turnover
5.62
2. Inventory turnover
7.15
3. Return on assets
18.27
4. Return on equity
(k)
Determine the missing amounts above. (Round amounts to the nearest dollar.)
The following summary information is taken from the annual reports of McDonald’s Corporation and Wendy’s International. All amounts are in millions.
McDonald’s
Wendy’s
2001
2000
2001
2000
Sales revenue
$14,870
$14,243
$2,391
$2,237
Operating income
2,697
3,330
307
271
Net income
1,637
1,977
194
170
Total assets
22,535
21,684
2,076
1,958
Stockholders’ equity
9,488
9,204
1,030
1,126
a. Compute profit margin, asset turnover, return on assets, financial leverage, and return
on equity for both firms for both years.
b. Which company is more profitable? What similarities or differences do you observe in how these two companies earned their profits during the periods shown?
Market to book value links company value to accounting numbers. It is related to a variety of attributes. Complete the table below by indicating whether the value of each attribute indicates a high market to book value company or a low one. The first item is completed as an example.
Following is the income statement and balance sheet of a company that just sold stock to the
public for the first time.
Balance sheet at July 31, 2004
Cash
$3,500
Accounts receivable
2,000
Inventory
1,700
Buildings, net
18,000
Total assets
$25,200
Accounts payable
$1,500
Wages payable
500
Common stock
10,000
Retained earnings
13,200
Total liabilities and equity
$25,200
Income statement for July 2004
Sales revenue
$5,000
Cost of sales
1,000
Gross profit
$4,000
Operating expenses:
Wages
$500
Depreciation
400
Interest
200
Operating income
$2,900
Income taxes
1,015
Net income
$1,885
The following terms are described under Objective 6 in this chapter. Find and list examples of each of these concepts in the financial statements above.
Operating Strategy Decisions and Product Pricing You are working as an assistant to the vice president for marketing at Long Life Incorporated, a startup manufacturer of a healthy, minimally refined breakfast cereal. Since little processing will be done, much of the cost of the product will be in the premium ingredients. The company will be investing $3 million in processing and packaging facilities to produce a maximum of 15,000 cases of cereal per month. It will advertise and market only in a restricted regional area in the foreseeable future, although expansion is possible in the long run. Fixed costs for operating the facility will be approximately $85,000 per month. Variable costs, primarily for ingredients and labor, are expected to be approximately $17 per case. In the past, most cereals of this sort have been sold at specialty stores for high prices.
However, in recent years, some have moved into supermarkets at prices that are competitive with those of traditional cereals. A marketing research study has given you estimated results after the first year for three possible scenarios:
1. Sell to supermarkets for $29 per case, spend $25,000 per month on advertising, and sell approximately 11,000 cases per month. The average price grocery stores pay competitors for a case of this size is $30, and $25,000 is a minimal monthly budget for advertising in the local area.
2. Sell to supermarkets for $31 per case, spend $40,000 per month on advertising, and sell approximately 12,000 cases per month.
3. Sell to specialty stores for $34 per case, spend only $7,000 per month advertising in health food periodicals, and sell approximately 7,500 cases per month.
Required
A. Prepare a schedule (using the format on the next page) that shows the pro forma (or expected) profit from each scenario.
B. Write a report for your company president and vice presidents in which you analyze each of the above strategies and make a recommendation concerning which one to choose.
C. Also include discussion of any long term trends and other outside factors that you feel should be considered in making this strategic decision.
Strategy 1
Strategy 2
Strategy 3
Selling price per case
Estimated monthly sales (cases)
Sales revenue
Expenses:
Fixed, per month
Advertising, per month
Variable per case
Total monthly expenses
Pro forma monthly profit
Pro forma annual profit % return on $3 million investment
Product Pricing Decisions You have been hired as a marketing manager for NuTech Appliance Company. The company manufactures major home appliances, such as refrigerators, stoves, and dishwashers. NuTech is about to add a new dishwasher to its lineup. The new appliance will have standard features, appearance, and quality, except that it will be considerably quieter than similar models from the competition.
The president of the company, Marta Feliz, has asked you to prepare a memo describing the factors you believe the company should consider in pricing the new product.
Required Write a memo to Feliz. Describe the measurement or measurements you would hope to maximize through a pricing decision. Then explain what factors should be considered, including information from within and outside of the company. Describe estimates that you would want to develop before making a final pricing decision.
Accrual and Cash Based Measurement of Success The information below is extracted from the 2001 annual reports of three personal computer companies.
Compaq
Apple
Dell
(In millions)
2001
2000
2001
2000
2001
2000
Sales
$33,554
$42,222
$5,363
$7,983
$31,168
$31,888
Net income (loss)
785
569
25
786
1,246
2,177
Total assets
23,689
24,856
6,021
6,803
13,535
13,670
Operating cash flow
1,482
565
185
868
3,797
4,195
Required Use appropriate analytical tools, including ratios, to answer the following questions.
A. Which company is most successful at generating net income from its assets?
B. Does this greater success result from the company using its assets more effectively to generate sales or from its generating greater profit from its sales? How do the profit margins compare?
C. Which company is most successful at generating cash flow from its assets?
Analyzing Cash Flow from Operations Selected information is presented below for two companies that compete in the same industry.
2005
2004
2005
2004
Sales revenue
$1,811
$1,476
$1,967
$2,212
Cost of goods sold
1,391
1,137
1,773
1,641
Ending accounts receivable
317
314
299
386
Ending inventory
115
216
132
355
From the statement of cash flows:
Net income
$131
$79
($163)
$85
Depreciation and amortization
29
21
31
25
(Increase) decrease in accounts receivable
21
86
87
70
(Increase) decrease in inventory
100
14
223
137
Increase (decrease) in accounts
payable and other current liabilities
121
62
32
55
Other items
19
26
41
5
Cash flow from operations
$341
$88
$105
($47)
Required Using this information, examine the details of how each company generates cash from operations.
A. Determine which company requires less time to convert inventory to sales. Consider this in relation to gross profit margins.
B. Determine which company requires less time to collect its receivables from its customers.
C. For each company and each year, examine and comment on the differences between net income and cash flow from operations. What does this show you about the operating strengths or weaknesses of the companies?
Evaluating Operating Performance The following information was taken from the 2005 annual report of Hogar Products, Inc. The company manufactures a wide variety of household products.
Year ended December 31
2005
2004
2003
(In millions, except per share data)
Net sales
$3,720
$3,336
$2,973
Cost of products sold
2,548
2,260
2,020
Gross income
$1,172
$1,076
$953
Selling, general, and administrative expenses
583
498
462
Trade names and goodwill amortization
55
32
24
Operating income
$534
$546
$467
Nonoperating (income) expenses:
Interest expense
60
76
59
Other, net
211
15
18
Income before taxes
$685
$485
$426
Income taxes
289
192
169
Net income
$396
$293
$257
Earnings per share:
Basic
$2.44
$1.81
$1.60
Diluted
$2.38
$1.80
$1.60
Required
A. How much did sales grow from 2003 to 2004 and from 2004 to 2005?
B. Restate each item on the income statement (except earnings per share) as a percent of net sales. [Hint: Sales always =100%; 2005 cost of product sold =68.5% ($2,548 _ $3,720).)
C. What have the changes in relative revenues and expenses had on operating income and net income over the three year period?
D. What conclusions can you draw about the company’s operating leverage? Are most of its costs fixed or variable?
Linking Operating, Investing, and Financing Activities Information is provided below for Minnesota Mining and Manufacturing Corporation (known as 3M) and Eastman Chemical Co. for 2001 and 2000.
3M Corp.
Eastman Chemical
(In millions)
2001
2000
2001
2000
Net sales
$16,079
$16,724
$5,390
$5,292
Net income (loss)
1,430
1,782
175
303
Total assets
14,606
14,522
6,092
6,550
Total stockholders’ equity
6,086
6,531
1,382
1,812
Required
A. Calculate profit margin, asset turnover, return on assets, financial leverage, and return on equity.
B. Discuss the results and compare the companies’ effectiveness, efficiency, operating strategy, use of investments in assets, and financing activity.
Comparing Results from Different Operating Strategies Big Bend, Inc. and Longbow, Ltd. have both been in the chemical business for several decades. Each has developed a strong reputation in the industry and both are known for strong management. Big Bend tends to sell specialty products in small batches that are custom made. Longbow operates more in large scale sales of commodity type products that become raw material for a wide variety of plastics and polymers. Selected information is presented below for two recent fiscal periods.
Big Bend
Longbow
(In millions)
2005
2004
2005
2004
Total assets
$34.20
30.2
$38.20
36.1
Total stockholders’ equity
9.96
8.82
17.3
16.3
Sales revenue
40.3
35.9
206.5
193.3
Net income
3.68
3.13
6.4
5.8
Required
A. Considering only the brief written descriptions of the two firms, would you expect one or the other to use a product differentiation strategy? Or cost leadership strategy? Explain.
B. Compute the profit margin, asset turnover, and return on assets for 2005 for both firms. Are your expectations from part A borne out by the data for 2005?
C. What changes in profit margin, asset turnover, and return on assets have occurred between 2004 and 2005?
D. Compute the return on equity for both firms for both years.
E. Which is a more successful strategy, product differentiation or cost leadership? Explain.
Evaluating Growth and Value Information is provided below from the 2002 annual reports of Sara Lee Corporation and Dell Computer.
(In millions)
2002
2001
2000
1999
1998
Sara Lee
Total assets
$13,753
$10,167
$11,611
$10,292
$10,784
Common stockholders’ equity
1,742
1,122
1,234
1,266
1,816
Sales
17,628
16,632
16,454
16,277
16,526
Dell
Total assets
$13,535
$13,670
$11,471
$6,877
$4,268
Common stockholders’ equity
4,694
5,622
5,308
2,321
1,293
Sales
31,168
31,888
25,265
18,243
12,327
Required
A. Calculate the annual growth in assets, common equity, and sales for each company from 1998 through 2002. (Hint: To compute the growth rate from year to year, use the following formula—[(later year amount +earlier year amount) +earlier year amount].)
B. Evaluate and compare the two companies’ growth rates. As an investor, would the difference in growth rates make one firm more attractive as an investment than the other? Explain.
Connecting Operating Activities, Financing Activities, and Value Billboards–R–Us and Outdoor SignCorp have the following selected information available.
2005
2004
2003
2002
Billboards–R–Us:
Total assets
$12,431
$11,665
$10,862
$9,989
Stockholders’ equity
3,939
3,326
3,551
3,382
Net income (millions)
804
199
704
761
Diluted earnings per share
1.62
0.37
1.4
1.54
Market value per share
28.5
20.63
24.25
24.81
Total market value
13,680
9,902
11,761
11,810
Outdoor SignCorp:
Total assets
$6,101
$5,533
$4,828
$4,077
Stockholders’ equity
2,246
1,816
1,390
1,528
Net income (millions)
740
694
331
644
Diluted earnings per share
5.48
5.17
2.45
4.78
Market value per share
97.13
77
67.5
69.13
Total market value
13,112
10,326
9,113
9,311
Required
A. Calculate the return on assets, return on equity, and market to book value for each year.
B. Evaluate the effects that operating activities and financing activities appear to have had on the value of each company to its stockholders.
C. Has the stock price responded as you would expect? Explain.
Evaluating Operating Performance Information is provided below for two companies that produce and sell audio magnification devices for the hearing impaired.
John, Inc.
Roberta Company
2005
2004
2005
2004
Sales revenue
825
770
352
330
Cost of goods sold
540
504
250
216
Gross profit
285
266
102
114
Operating expenses
168
189
70
60
Operating income
117
77
32
54
Interest expense
30
20
10
8
Income before tax
87
57
22
46
Tax
30
20
8
16
Net income
57
37
14
30
Accounts receivable
78
73
39
34
Inventories
139
136
85
71
Fixed assets
900
850
600
550
Total assets
1,630
1,530
850
765
Required
A. For each company and each year, compute the following measures:
1. Profit margin
2. Gross profit margin
3. Operating profit margin
4. Asset turnover
5. Accounts receivable turnover
6. Inventory turnover
7. Return on assets
8. Fixed asset turnover
9. Times interest earned
10. Day’s sales in inventory
11. Average collection period for accounts receivable
B. For each year, prepare a schedule summarizing which company had the better value of each ratio.
C. Prepare a schedule that shows, for each company, whether the value of each ratio improved or declined.
D. Which firm had the stronger operating performance during the periods studied? Briefly summarize why.
Usefulness and Limitations of Financial Statement Information You work as part of a team that selects parts suppliers for a large manufacturer. Your company is highly dependent on your suppliers, and you want long term relationships. You want suppliers who are financially stable, without cash flow problems. If they need more capacity in order to grow with you, you want them to be able to attract additional investors. One of your team members claims that financial statements tell you everything you need to know to determine the future stability and growth potential of a supplier. Another claims that financial statements are useless in the process, and that talking with the people in the company is the only route to judging its future.
Required Discuss the strengths and weaknesses of financial statements in assisting you as you try to determine the stability and growth potential of possible suppliers. What can you learn about a company from a standard set of financial statements? What are the limitations of financial statements? What would you look at in the statements to judge a supplier’s ability to remain in business and avoid cash flow problems? What relationships in the statements would help you judge whether the company could attract additional capital for growth?
Value of Accounting and Auditing Standards In the United States, the Financial Accounting Standards Board sets measurement and reporting standards for financial statements. For large companies, the Securities and Exchange Commission imposes some additional standards. The Auditing Standards Board of the American Institute of CPAs determines standards for conducting an audit. Similar bodies perform these functions in other countries. A major effort is being made to set worldwide standards.
Required Describe and evaluate these standards, answering the following questions.
A. What are measurement and reporting standards?
B. Why are measurement and reporting standards important to users of financial statements?
C. What is an audit?
D. Why are auditing standards important to financial statement users?
E. What advantages and disadvantages do you see to having separate accounting and auditing standards for each country?
Preparing an Income Statement Shriver Company’s accounting system listed the following information for the company’s 2004 fiscal year (in millions):
Average common shares outstanding
2.4
Cost of goods sold
$170.30
Extraordinary gain
18.2
Gain on sale of securities
8.6
General and administrative expenses
75.5
Income taxes (35% of pretax income)
Interest expense
12
Interest income
5.9
Loss associated with cumulative effect of accounting change
4
Loss from discontinued operations
13.1
Sales of merchandise
320.8
Selling expenses
30.2
Required Prepare an income statement for Shriver Company for the year ended December 31, 2004. Assume that the tax rate of 35% applies to special items as well as ordinary income. (Hint: Discontinued operations are listed before extraordinary items, which are listed before accounting changes.)
Interpreting an Income Statement Worldwide Corporation reported the following income statement for 2005.
(In millions)
2005
2004
2003
Product sales
$3,355
$3,298
$3,236
Service sales
2,941
2,591
2,543
Sales of products and services
6,296
5,889
5,779
Cost of products sold
2,549
2,523
2,508
Cost of services sold
1,931
1,754
1,743
Costs of products and services sold
4,480
4,277
4,251
Provision for restructuring
86
23
249
Marketing, administration, and general expenses
1,686
1,184
1,313
Other income and expenses, net
149
288
154
Interest expense
233
134
165
Loss from continuing operations before income taxes and minority interest in income of consolidated subsidiaries
40
17
353
Income taxes
7
13
116
Minority interest in income of consolidated subsidiaries
11
9
9
Loss from continuing operations
44
13
246
Discontinued operations, net of income taxes:
Income from operations
135
90
71
Estimated loss on disposal of discontinued operations
76
95
Income (loss) from discontinued operations
59
90
24
Income (loss) before cumulative effect of change in
accounting principle
15
77
270
Cumulative effect of change in accounting principle
Postemployment benefits
56
Net income (loss)
$15
$77
$326
Required Answer each of the following questions.
A. For 2005, calculate the gross profit on product sales and on service sales. Why are these shown separately?
B. What is a “provision for restructuring”? What is a “discontinued segment”? Why is it that the restructuring provision is part of operating income, but the discontinued segment is not?
C. Some businesses show interest expense in a separate section with a title like “Other Revenues and Expenses,” below Income from Operations. Would Worldwide’s operating income have been positive in the years presented if it did not include interest expense?
D. Why is “income taxes” a positive number, not an expense?
E. What is a “cumulative effect of change in accounting principle”?
F. Which would be of more use in attempting to predict the financial future of the company:
income from continuing operations or the final net income numbers, including the discontinued operations and the effect of the change in accounting principle?
G. Why are the effects of the discontinued segment and the change in accounting principle presented net of any tax effect?
Presentation of the Income Statement Pelican Enterprises had the following account balances in its general ledger at June 30, 2004, the end of the company’s fiscal year. All adjusting entries except for the accrual of income taxes at 30%) had been entered. The company had an average of 900,000 shares of common stock outstanding during the year.
General ledger account balances (in thousands)
Accounts receivable
$349
Land
$1,980
Accumulated depreciation
922
Loss on sale of old machinery
255
Advertising expense
1,224
Merchandise inventory
471
Buildings and equipment
4,811
Notes payable, long term
150
Cash
482
Preferred stock, 7%
300
Common stock
2,400
Prepaid advertising
54
Cost of goods sold
3,660
Rent expense
546
Depreciation expense
102
Rent payable
450
Extraordinary gain on extinguishment of debt
40
Retained earnings
513
Sales revenue
6,930
Investments, long term
250
Service revenue
3,382
Interest revenue
44
Wages expense
855
Interest expense
124
Wages payable
32
Required
A. Prepare an income statement in good form, including earnings per share information.
B. Have the closing entries been made to the accounting system? How can you tell? (Hint: You might want to review the accounting cycle in Chapter F3.)
C. What is the amount of net income available to common stockholders? Why is this important information?
D. Why do you think that GAAP require that gross profit, operating income, pretax income, and net income be separately disclosed?
The Effect of Accounting Choices Ginsberg Company is a recently formed, publicly traded company. At the end of its most recent fiscal year, the company reported the following information.
a. Sales revenues were $13,680,000, and 360,000 units were sold. Credit sales were $10,000,000. Uncollectible accounts associated with credit sales are estimated to be between 3% and 4%.
b. At the beginning of the year, 140,000 units of inventory were on hand at a unit cost of $10 per unit; during the year, 250,000 units were purchased at $10.50, and, later, 150,000 units were purchased at $11.50 per unit.
c. Plant assets included equipment with a book value of $3,375,000 and buildings with a book value of $8,260,000. The equipment has an estimated remaining useful life of between four and seven years. The buildings have an estimated remaining useful life of between 25 and 35 years.
d. Intangible assets (excluding goodwill) cost $1,200,000 and have a remaining useful life of no less than 10 years.
e. The company has the option of adopting a new accounting standard for the fiscal year. If the standard is adopted, the cumulative effect of the accounting change, before the tax effect, will be a loss of $1,100,000.
f. The company’s tax rate is 34%. Other operating expenses were $6,245,000. Interest expense was $460,000. There were 500,000 shares of common stock outstanding throughout the year.
Management has not yet made decisions about how to treat items a through e. A choice is necessary in each instance. The chief financial officer has asked you to determine the range of net income that might be reported depending on the choices that are made.
Required Prepare two different pro forma (projected) income statements for the year.
A. With the first income statement, show the minimum net income the company could report under GAAP.
B. With the second income statement, show the maximum net income that could be reported under GAAP.
C. What does this suggest to you about comparing the reported net income of one firm versus the others?
Reporting Equity Income, Noncontrolling Interest, and Pension Information (Based on the Other Topics section.) A partial income statement for Half Moon, Inc. is reported below.
Half Moon, Inc. Partial Income Statement For Year Ending December 31, 2004
Sales revenue
$3,504,600
••
Operating income
$587,300
Equity income in related company (Able Co.)
40,000
Income before income taxes
$627,300
Provision for income taxes
219,500
Income before noncontrolling interests
$407,800
Noncontrolling interest in net income of subsidiary (Baker Co.)
2,466
Net income
$405,334
In addition, the following disclosure was found in the notes to the financial statements.
Projected benefit obligation
$1,500,000
Fair value of plan assets
1,300,000
Pension liability
$200,000
Service cost
$103,400
Return on plan assets
100,100
Net pension expense
$3,300
Required Explain each of the following.
A. What information is conveyed by the line labeled “Equity income in related company”? Describe the situation that must prevail for this line to appear on an income statement.
B. What information is conveyed by the line labeled “Noncontrolling interest in net income of subsidiary”? Describe the situation that must prevail for this line to appear on an income statement. Why is this amount subtracted in this case?
C. What information is conveyed by each of the first three lines of Note 7?
D. What information is conveyed by each of the second set of three lines of Note 7?
Examining Operating Activities Appendix B of this book contains a copy of the 2002 annual report of General Mills, Inc.
Required Review the annual report and answer each of the following questions.
A. What was the primary inventory estimation method used by General Mills? What is the effect on the company’s cost of goods sold and operating income of using this primary method as compared to other methods? (Hint: Look at Notes 1c and 6. The “Reserve for LIFO” is an estimate of the difference between FIFO and LIFO values.)
B. What was the amount of General Mills’ allowance for doubtful accounts for 2002? Did the relationship between estimated doubtful accounts and net sales change from 2000 to 2002?
C. How much income tax expense did General Mills recognize as expense for 2002? How much income tax did the company owe for 2002? What were the primary causes of the difference between income tax expense and income tax payable? How much income tax did General Mills pay in 2002? (Hint: See Note 16 as well as the statement of earnings. The total to be paid for 2002 is “Total Current.”)
D. How much did General Mills report for depreciation and amortization and for interest expense in 2002? How much cash did General Mills pay for depreciation, amortization, and interest in 2002? (Hint: See the income statement and Note 13.)
The Effect of Accounting Choices on Reported Results Sunlight Incorporated and Moonbeam Enterprises both began operations on the first day of 2004. Both operate in the same industry, sell the same products, and have many of the same customers. Both companies have just reported financial results at the end of 2004. By a remarkable coincidence, the sales revenue reported by both companies was exactly the same.
Overall, however, Moonbeam’s net income was approximately 75% greater than Sunlight’s. You are a little surprised by this because it was generally thought by those in the industry that Sunbeam had been the better managed and more successful firm.
Income Statements for Year 2004
Sunlight Incorporated
Moonbeam Enterprises
Sales revenue
$31,000
$31,000
Cost of goods sold
20,000
18,600
Gross profit
$11,000
$12,400
Operating expenses:
Depreciation
1,100
1,100
Insurance
550
610
Supplies
1,300
1,300
Uncollectible accounts
1,240
310
Warranties
620
0
Wages
1,500
1,570
Total operating expenses
6,310
4,890
Operating income
4,690
7,510
Interest expense
900
900
Pretax income
3,790
6,610
Income tax expense
1,298
2,314
Net income
$2,492
$4,296
Earnings per share
$1.25
$2.15
Upon reviewing the notes that accompany the financial statements, however, you observe the following.
1. At year end, Sunlight recorded allowances in its accounting system for expected sales discounts (of $113) and expected sales returns ($1,345). Moonbeam, while having the same types of products and customers, did not believe it had enough information to record estimates after only one year in business.
2. Both companies reported sales totaling 1,200 units. Sunlight recognizes revenue when goods are shipped to customers. Moonbeam recognizes revenue when the order is received. As of year end, the last 100 units that Moonbeam has reported as sales have not yet been shipped to customers because Moonbeam is temporarily out of stock. An employee forgot to re order the item on time and now the manufacturer’s plant is down for annual maintenance at year end. Production is scheduled to resume on January 15.
As soon as these units are received at Moonbeam’s warehouse, they will be shipped to the customers who ordered them.
3. Moonbeam used the perpetual FIFO method of inventory estimation, but Sunlight used perpetual LIFO. Both companies had the same inventory costs and reported inventory transactions as follows.
Event
Units
Cost per Unit
Total Cost
Beginning inventory
0
$0
$0
Purchase
200
12
2,400
Purchase
500
15
7,500
Sales
300
Purchase
400
17
6,800
Sales
500
Purchase
300
19
5,700
Sales
300
Sales*
100
*As the wholesale cost of goods increased during the year, both firms increased selling prices, too. This last batch of sales (as reported by each firm) was sold at $30 per unit. Unlike other sales, this batch of goods was sold for cash and no returns were allowed.
4. At year end, both companies were concerned about uncollectible accounts. Being new in the business, neither firm had much history upon which to base an estimate. Nevertheless, Sunlight estimated that approximately 4% of sales would be uncollectible. Moonbeam was more optimistic and estimated the rate at only 1%.
5. The companies differ in how they account for warranty expenses. Sunlight’s management estimated the cost of future warranty claims (for goods sold during the year just ended) and recorded an expense for that amount. Moonbeam decided that the amount would be immaterial and it would just charge these claims to expense in the later years when they were paid.
Required Which firm had the better financial results for its first year of operation? Why? Prepare any tables or schedules that you think would support your conclusion or be helpful to illustrate the basis for your conclusion.
Information is provided below for two companies that produce and sell plastic containers.
Caseopia
Dragoon
(In thousands)
2004
2003
2004
2003
Sales revenues
$750
$700
$320
$300
Cost of goods sold
450
420
208
180
Gross profit
300
280
112
120
Operating expenses
120
135
50
43
Operating income
180
145
62
77
Net income
100
87
37
46
Accounts receivable
46
43
23
20
Inventories
82
80
50
42
Total assets
960
900
500
450
Required
A. Compute profit margin, gross profit margin, operating profit margin, asset turnover, accounts receivable turnover, inventory turnover, and return on assets for each company.
B. Use these ratios to evaluate the operating activities of each company and to compare the companies’ performance.
You are preparing for a meeting at which your company will discuss its selling price for a new product. You have already made the decision to invest $2.3 million in production facilities with a capacity to produce 350,000 units per year. Fixed expenses, including depreciation and minimal advertising, will be $300,000 per year. Variable expenses will be $4 per unit. Your marketing people have developed three sales scenarios:
a. At a price of $7 per unit, below much of the competition, you sell 200,000 units per year.
b. At a price of $9 per unit, the average among the competition, you sell 135,000 units per year.
c. At a price of $7 per unit, with an additional $400,000 per year spent to advertise your low price, you sell 300,000 units per year. Prepare a schedule (according to the following format) that shows the pro forma (or expected) profit from each scenario.
The Lakeside Symphony Association is a not for profit organization. The primary function of the association is to operate the Lakeside Symphony Orchestra for the benefit of local citizens. The board of directors of the organization is discussing ticket prices for the upcoming season. Ticket receipts do not cover all costs of a concert; donations must be solicited for the remainder, but finding enough donors is difficult, and funds are always scarce. Each concert has fixed orchestra costs of approximately $28,000, primarily for paying the musicians. The only variable costs are programs, tickets, and refreshments served at a reception following the concert; these total about $2 per attendee. Orchestra managers estimate that they can sell 1,300 tickets for the average concert at $12, 1,100 tickets at $15, or 800 tickets at $20. Which option do you recommend? Why? Are the financial measurements used in this chapter appropriate for a not for profit situation like this? Why or why not? What nonfinancial considerations should enter into the decision?
Garden Company has the capacity to produce 200,000 tillers. Variable costs are $30 per tiller. Fixed costs are $1,500,000. Should the company aim to sell 200,000 at $100 each, 160,000 at $125 each, or 125,000 at $160 each? Explain your recommendation. What will the company have to do to carry out the strategy you recommend? Three companies have the following financial results:
Company A
Company B
Company C
Profit margin
0.05
0.4
0.25
Asset turnover
6
0.75
1.2
Return on assets
30%
30%
30%
What can you conclude about the financial results and the operating strategy of each company?
Selected information from the 2001 annual reports of Hershey Foods Corp. and William Wrigley Jr. Co. is provided below. Both companies are prominent in the sugar and confectionary products industry.
(In millions)
Hershey Foods
Wrigley
Net sales
$4,557
$2,430
Net income
207
363
Total assets
3,247
1,766
Compare the operating strategies of the two companies by calculating profit margin, asset turnover, and return on assets. Which company appears to be doing the better job with its strategy?
The numbers below are from the 2001 annual reports of two major airlines.
Southwest Airlines
Delta Air Lines
(In millions)
2001
2000
2001
2000
Sales
$5,555
$5,650
$13,879
$16,741
Net income (loss)
511
603
1,216
828
Total assets
8,997
6,670
23,605
21,931
Calculate return on assets, asset turnover, and profit margin. Which airline appears to be more successful? Do you find evidence of differences in operating strategies, or do both appear to compete on the same basis? What could the less successful line do to improve profits?
Styles, Inc., a clothing manufacturer, reported the information given below over a three year period.
2005
2004
2003
Sales
$9,000
$6,000
$3,000
Net income
1,683
852
288
Total assets
20,036
10,650
3,692
Inventory
1,500
960
500
Cost of goods sold
5,500
3,500
1,800
Fixed assets
4,000
2,500
1,500
(a) Compute the firm’s profit margin, asset turnover, day’s sales in inventory, fixed asset turnover, and return on assets for each year shown. (b) Discuss the company’s operating strategy over this time period.
Information is provided below for Federated Department Stores, owner of several department store chains, including Bloomingdale’s, Macy’s, and The Broadway. The amounts given are from Federated’s annual report for the year ended February 2, 2002.
(In millions)
Fiscal 2001
Fiscal 2000
Sales
$15,651
$16,638
Cost of goods sold
9,584
9,955
Operating income
1,104
1,691
Net income (loss)
276
184
Accounts receivable
2,379
2,435
Merchandise inventories
3,376
3,626
Total assets
15,044
15,574
Cash provided by operating activities
1,372
1,332
Calculate inventory turnover, accounts receivable turnover, gross profit margin, and operating profit margin. Compare your results with those for Wal Mart shown below. To what extent are the differences explained by the differing operating strategies of the two retailers?
Footpedal Enterprises has been in business for five years. This past year was the best year yet, as demonstrated by several indicators shown below.
2005
2004
2003
2002
2001
Inventory turnover
5.2
4.7
4.3
4.5
4.1
Accounts receivable turnover
6
5.7
5.4
5.4
5.3
Gross profit margin
23.2
22.8
22.9
22.6
21.8
Operating profit margin
12.1
12
11.9
11.8
11.9
Your new assistant wonders why upper management is so happy that the inventory turnover, the accounts receivable turnover, the gross profit margin, and the operating profit margin all increased this year. Explain why an increase in each of these items is a positive indicator.
The selected information below has been taken from the last two annual reports of Rasheed Company.
2005
2004
Accounts receivable
$1,466
$1,330
Merchandise inventory
2,093
1,947
Total assets
13,707
12,829
Total stockholders’ equity
4,386
4,180
Sales revenue
14,472
13,971
Cost of goods sold
11,481
11,606
Operating income
1,636
1,509
Net income
1,170
1,020
Interest expense
1,000
900
Fixed assets
8,000
7,500
a. Compute each of the following ratios for both years.
1. Inventory turnover
2. Accounts receivable turnover
3. Gross profit margin
4. Operating profit margin
5. Profit margin
6. Asset turnover
7. Return on assets
8. Return on equity
9. Times interest earned
10. Day’s sales in inventory
11. Average accounts receivable collection period
12. Fixed asset turnover
b. Has the company’s financial performance improved or deteriorated during the most recent year? Was the firm more effective, more efficient, both, or neither? Which factors contributed to the improvement? Did any factors hurt overall performance? Explain.
Think carefully about each of the following statements. For each one, indicate whether you believe it to be always true, generally true, generally false, or always false. For any item you judge to fall into the last three categories, describe your reasoning.
a. Sales discounts are reported on the income statement as an operating expense.
b. When a company writes off an uncollectible account against Allowance for Doubtful Accounts, the net amount of Accounts Receivables reported on the balance sheet does not change.
c. Jabba Company purchased inventory for its retail store. Jabba should include in the cost of this inventory the amount charged by the freight company to deliver the goods to Jabba’s store.
d. Most retail stores will report three categories of inventory: raw materials, work inprocess, and finished goods.
e. When merchandise is sold to customers, the entries to Sales Revenue and Accounts Receivable will be for different amounts than the entries to Merchandise and Cost of Goods Sold.
f. A purchase of merchandise for later resale to customers has no effect on the income statement.
g. Purchase discounts received from vendors should be deducted when determining and reporting the cost of merchandise.
h. Ford Motor Company just received 1,000 steering wheels for a particular line of cars it manufactures. The cost of these items should be recorded initially in Work in Process Inventory.
i. The cost of wages earned by factory employees should be reported on the income statement as Wages Expense during the accounting period in which employees earned them.
j. Diggin Deep Company, a gold mining firm, sold gold bars to Lookin’ Good, Inc. The second firm is a manufacturer of jewelry. Diggin Deep sold finished goods but Lookin’ Good bought raw materials.
Domestic Company sells kitchen appliances. During the year just ended, the company sold 210,000 units and recorded cost of goods sold totaling $42 million. If periodic LIFO had been used, the company would have reported $44 million of cost of goods sold. Inventory to replace the units sold was purchased during the year for $45 million. The year end Accounts Receivable balance did not differ from the prior year end. The company’s income tax rate was 30%. Sales revenue for the year was $60 million and other expenses (all paid in cash) were $12 million.
a. What would net income have been if Domestic had used periodic LIFO instead of periodic FIFO?
b. What would the company’s cash flow from operating activities have been if it had used periodic LIFO instead of periodic FIFO?
c. Does the inventory method that results in increased net income also produce increased operating cash flow? Explain why or why not.
The following information regarding inventory transactions is available for the month of May.
Date
Type of Event
Number of Units
Unit Cost
Total Cost
1 May
Beginning inventory
100
$12
$1,200
3
Purchase
50
14
700
12
Sale
70
15
Sale
60
20
Purchase
100
15
1,500
28
Sale
60
Determine the correct balances at May 31 for Merchandise Inventory and Cost of Goods Sold under each of the following inventory methods: (a) periodic FIFO, (b) periodic LIFO, and (c) weighted average.
Small Part Company had the following information regarding inventory transactions available at the end of October. Year to date Cost of Goods Sold at October 1 was $236,700.
Date
Type of Event
Number of Units
Unit Cost
Total Cost
1 Oct
Beginning inventory
9,000
$10
$90,000
4
Purchase
3,000
12
36,000
11
Sale
8,000
15
Sale
2,000
22
Purchase
10,000
14
140,000
29
Sale
5,000
Determine the correct year to date balances at October 31 for Merchandise Inventory and Cost of Goods Sold under each of the following inventory methods: (a) periodic FIFO, (b) periodic LIFO, and (c) weighted average.
Randolph Company is a retailer that sells appliances to institutions such as schools, universities, and state governments. During the month of January, Randolph Company recorded the following information:
Units
Unit Cost
Total Cost
January 1 inventory
550
$300
$165,000
Purchases January 5
100
305
30,500
Sales January 7
300
Purchases January 10
600
310
186,000
Sales January 31
500
Assuming Randolph Company uses a perpetual FIFO inventory system, determine the cost of goods sold and value of the ending inventory.
A partial income statement is shown below for Mavis Company.
(In thousands)
2004
Income before extraordinary items and taxes
$4,523
Provision for income taxes
1,036
Income before extraordinary items
$3,487
Extraordinary loss from condemnation of land for a freeway (net of tax benefits of $322)
644
Net income
$2,843
Earnings per share
Basic
Diluted
Income before extraordinary items
$1.16
$1.00
Extraordinary items
0.21
0.19
Net income
$0.95
$0.81
(a) Why are earnings per share presented for both before and after the extraordinary items?
(b) On how many shares was Mavis computing basic earnings per share? Diluted earnings per share? (c) What kinds of items might account for the additional shares used for the calculation of diluted earnings per share?
The Oregon Ironworks Company had the following income statement items for the year 2004.
Income from continuing operations, before taxes
$228,000
Current year loss from discontinued operations
10,750
Gain from sale of discontinued operations
2,750
Extraordinary loss from hurricane
22,500
Cumulative effect from change of depreciation method
6,000
Tax rate, applicable to all income statement items
30%
Number of shares of common stock outstanding during 2004
79,800
a. Beginning with “Income from continuing operations, before taxes,” prepare the remaining sections of the income statement.
b. Calculate earnings per common share for all sections of the income statement. The company has no preferred stock outstanding. (Note: The information about special items should be listed in the following order: discontinued operations, extraordinary items, changes in accounting method.) Explain whether each of the following would be expensed on the income statement in 2004 or in some later year, and why.
a. Inventory purchased in 2004 but sold in 2005.
b. Estimated warranty costs for goods sold in 2004; the warranty servicing will take place in 2005 and 2006.
c. Bad debts caused by 2004 sales; the actual bad receivables will not be identified until a later year.
d. Research and development costs incurred in 2004 but aimed at producing a better product in later years.
Income Statement Preparation On January 1, 2004, Pete Rabbit began Leafy Green Corporation, a salad bar supply business, by investing $5,000 cash and a delivery van worth $7,200 in exchange for 1,000 shares of $2 par common stock. Pete expects the van to have a remaining life of three years with no salvage value; he plans to use straight line depreciation. Two friends invested $2,000 each, receiving 150 shares of stock each.
The next day, Leafy Green borrowed $8,400 at 8% annual interest for operating funds. The loan is to be repaid or refinanced in three months.
Salad ingredients for the month of January cost $8,000; Leafy Green has paid for 75% of this. The company has delivered prepared salad bar materials to three customers, each of whom has been billed $5,000; two of the three have paid. No ingredients were on hand at the end of the month. Other operating expenses, paid in cash, were $4,500.
Required Prepare an income statement for Leafy Green Corporation, for the month of January 2004. Include earnings per share.
Revenue Recognition Several situations in which the timing of revenue is in doubt are listed below.
a. An appliance manufacturer sent out a truckload of dishwashers FOB destination in late January; they arrived February 2 and were paid for in March. Monthly income statements are prepared.
b. A magazine publisher sold two year subscriptions for a monthly publication.
c. An auto dealer sold five year service contracts for cash at the time of the auto sale.
d. A home decorating center sold wallpaper with a 60 day right to return of up to 25% of an order. For the past several years, returns have been fairly consistent, with one in 10 customers returning some paper; the average return is 1.2 rolls.
e. A bridge construction firm is involved in only one project at a time; the average project takes three years. The contract price is firm and definitely collectible; total costs of the project can be estimated.
Required First, explain what events generally must occur before any revenue is recognized. Then discuss when each of the above situations should result in revenue recognition, and why.
Revenue Recognition The following excerpt is from Unisys Corporation’s 2001 annual report.
Revenue Recognition. Revenue from hardware sales is recognized upon shipment and the passage of title.…Revenue from software licenses is recognized at the inception of the initial license term and upon execution of an extension to the license term.…Revenue from equipment and software maintenance is recognized on a straight line basis as earned over the lives of the respective contracts.…For contracts accounted for on the percentage of completion basis, revenue and profit recognized in any given accounting period is based on estimates of total projected contract costs, the estimates are continually reevaluated and revised, when necessary, throughout the life of a contract.
Required What is meant by revenue recognition? Why does Unisys use different revenue recognition principles for different types of revenue? What are the critical events for each of these types of revenue? Why is estimation involved in revenue recognition for the multiyear, fixed price contracts?
Computing Accounts Receivable Georgia Company reported accounts receivable of $16.5 million at the end of its 2004 fiscal year. This amount was net of an allowance for doubtful accounts of $1,800,000. During 2005, Georgia sold $56.5 million of merchandise on credit. It collected $57.9 million from customers. Accounts valued at $1,980,000 were written off as uncollectible during 2005. Georgia’s management estimates that 10% of the year end Accounts Receivable balance will be uncollectible.
Required Answer each of the following questions:
A. What amount will Georgia report for accounts receivable and the allowance for doubtful accounts at the end of 2005?
B. What is the Doubtful Accounts Expense for 2005?
C. How will the accounts receivable and allowance accounts be presented on the balance sheet? Show the balance sheet.
D. Why do companies record expenses for doubtful accounts based on estimates from receivables or sales during the prior year rather than recording the expenses when accounts are written off in a future period?
E. If estimated uncollectibles as a percentage of sales or receivables were to increase over several years, what information might this provide to decision makers?
Classification of Manufacturing Costs The following information is taken from the records of the Carolby Company, a manufacturer of lawn furniture. Indicate whether the cost of each item should be included as part of the finished goods cost or should be treated as an expense. For the items that become part of the cost of finished goods, indicate whether each should be designated as materials, labor, or factory overhead.
a. Salaries of sales office staff
b. Electric utilities for the factory area
c. Office supplies
d. Paint and miscellaneous plastic parts
e. Depreciation on factory equipment
f. Depreciation on delivery vans
g. Salaries of factory foremen
h. Miscellaneous factory supplies
i. Steel rods used for chair frames
j. Plastic sheets used for table tops
k. Salaries of furniture assemblers
l. Insurance on the factory
m. Insurance on the administrative offices
n. Advertising in trade magazines
o. Lawn furniture sold to retailers
p. Rental of storage facilities for materials
q. Rental of storage facilities for finished goods
Required Briefly explain your reasoning for classifying the various items as part of the cost of goods manufactured or as an expense.
Inventories Modern Industries manufactures a variety of computer parts and accessories in a rapidly changing technological environment. At year end 2004, it reported the following comparative information regarding inventories.
(In millions)
2004
2003
Raw materials and parts
$14
$16
Work in process
28
31
Finished goods
25
28
Total inventories
$67
$75
The 2004 income statement reflected cost of sales of $3,165 million. In the operating activities section of the statement of cash flows, the $8 million decrease in inventories was added to net income. Notes to the financial statements included the following:
• Inventories are reported at the lower of cost (first in, first out) or market. If the cost of the inventories exceeds their market (replacement) value, a write down to market value is taken currently.
• The company participates in a highly competitive industry that is characterized by rapid changes in technology, frequent introductions of new products, short product life cycles, and downward pressures on prices and margins.
Required Answer the following questions related to Modern Industries’ inventories.
A. Describe the nature of each of the three inventories listed on the balance sheet. When does each become an expense?
B. Why is the inventory decrease added to net income on the statement of cash flows?
C. Many U.S. corporations use the LIFO inventory method to save income taxes. Why might a computer industry manufacturer like this firm decide to use FIFO instead? Explain.
Inventory Transactions and Periodic Inventory Costing Methods Culture Music Store had the following selected account balances on October 1.
Merchandise inventory (1,000 units)
$7,000
Accounts receivable
15,000
Allowance for doubtful accounts
1,200
Warranty obligations
500
Goods are sold with a 60 day money back guarantee against defects. During October, the following transactions occurred.
1. The store purchased 4,000 units of inventory on credit at a total invoice cost of $32,000. The goods, which were received in October, were purchased FOB destination and the seller paid freight costs of $250.
2. During the first week of the month, 700 units were sold on credit at prices averaging $12 each.
3. A clerk noticed that 50 recordings purchased in part 1 were mislabeled. These units were returned to the vendor for full credit.
4. During the second week, a cash only sale was held and 1,200 units sold at an average price of $10 each.
5. Customers returned a total of 53 units that had been sold in part 2. The goods were in salable condition and returned to the shelf.
6. The vendor was paid in full for the goods purchased in part 1.
7. Checks were received from customers who purchased goods in part 2. All took the 2% discount that was offered for paying within 10 days.
8. A total of 1,600 units were sold during the rest of the month at prices averaging $13. Three quarters of the sales were on credit.
9. At month end, management estimated that 10% of the goods sold in parts 4 and 8 would be returned as defective.
10. Also at month end, management estimated that $344 of this period’s credit sales would be uncollectible.
Required
A. Show how each of the transactions would be entered into the accounting system assuming the firm uses the periodic FIFO inventory method.
B. Prepare an income statement for the month of October assuming that operating expenses (other than warranty expense and doubtful accounts expense) totaled $2,500 and the company’s tax rate is 35%.
C. By what amount would net income have been different if the periodic LIFO method had been used? Prepare a schedule that proves your solution.
D. By what amount would net cash flow from operating activities have been different if the periodic LIFO method has been used? Explain your solution.
Accounting Errors Regarding Operating Activities At year end, the accounting department at Bell Jones Industries had prepared the following balance sheet and income statement.
Balance sheet
Cash
$58,000
Accounts receivable
215,000
Less: Allowance for returns
9,000
Allowance for doubtful accounts
3,000
Merchandise
136,000
Buildings and equipment
413,000
Less: Accumulated depreciation
107,800
Land
79,000
Total assets
$799,200
Accounts payable
$108,200
Wages payable
25,000
Warranty obligations
61,000
Common stock
300,000
Retained earnings
305,000
Total liabilities and stockholders’ equity
$799,200
Income statement
Net sales
$1,855,000
Service contracts
792,000
Cost of goods sold
1,298,500
Operating expenses:
Wages
537,300
Rent
60,000
Advertising
282,000
Doubtful accounts
0
Depreciation
26,800
Warranties
55,000
Operating income
$387,400
Interest revenue
1,350
Income before taxes
388,750
Provision for taxes
136,063
Net income
$252,687
Just prior to the arrival of the outside auditors, one of the accounting staff brought a list of items to the chief financial officer. The staff member was concerned that these items had not been properly accounted for in the financial statements.
1. A source document showing a customer’s return of goods had been missing until just now and had not been processed through the accounting system. The goods had been sold on account to the customer for $9,000 during the current year and were returned to the warehouse for sale to others. The company’s normal gross profit on sales is 30%.
2. Just before year end, inventory had been purchased on credit at a cost of $60,000, FOB destination. By year end, it had not yet arrived but it had been included in the ending inventory anyway.
3. At the end of the prior year, there was $80,000 of inventory in transit from a supplier. The goods had been purchased FOB shipping point but had not yet arrived. The goods had been included in last year’s ending inventory anyway.
4. An error had been made in computing the warranty costs for goods sold during the current year. A total of $55,000 had been charged to Warranty Expense, but the correct amount was $75,000.
5. Near year end, a $100,000 service contract was obtained from a major customer. It was a renewal of an existing contract that would otherwise have expired during the coming year. Because this type of work had been performed many times before for this customer, the contract was entered into the accounting system as a credit sale during the year just ended. Collection of the cash will occur as the services are performed.
6. The adjusting entry to allowance for returns had not yet been recorded at year end. Using the firm’s usual approach, an additional $10,300 should be recorded.
7. No adjusting entry had been made at year end to account for doubtful accounts. Using the firm’s usual approach, $5,960 should be charged to expense.
Required
A. Show any entries to the accounting system that you believe should be made as a result of this information. If an item does not require an entry, explain why.
B. What is the proper amount of operating income that should be reported for the period? Prepare a schedule to show how you determined this amount.
Periodic Inventory Estimation and Income Control Rousseau Company uses the periodic LIFO inventory estimation method. At the beginning of the current fiscal year, the company’s inventory consisted of the following:
Units
Unit Cost
Total Cost
8,000
$22
$176,000
4,000
23
92,000
2,000
32
64,000
2,000
34
68,000
16,000
$400,000
These units were produced over several years, during which inventory costs had increased rapidly. During the current year, Rousseau produced 20,000 additional units of inventory at an average cost of $36 per unit. The average sales price of units sold during the year was $55.
Required Answer the following questions.
A. What would be Rousseau’s gross profit and average gross profit per unit if it sold 20,000, 24,000, 28,000, or 36,000 units during the year?
B. Assume that Rousseau sold 36,000 units during the year. How many units would it need to produce to minimize the tax effect of its gross profit? How many units would it need to produce to maximize its gross profit?
C. If you were a manager of Rousseau and you wanted to control the amount of gross profit reported by the company, what could you do? If you wanted to develop an accounting standard that could prevent this type of management manipulation of income, what kind of standard might you propose?
Accounting Choice Decisions Shim Company reported sales revenue of $10 million for the year. The company uses FIFO for inventory estimation purposes. Cost of goods sold was $3.8 million. If the company had used LIFO, its cost of goods sold would have been $4.5 million. The company reported depreciation expense of $1.2 million on a straight line basis. If the company had used accelerated depreciation, it would have reported depreciation expense of $1.7 million. Other expenses, excluding income tax, were $3 million. The company’s income tax rate was 30%.
Required
A. Compute Shim’s net income as reported and as it would have been reported if LIFO and accelerated depreciation had been used.
B. What effect would the choice of accounting methods have on the company’s cash flows from operating activities during the year if the same methods were used for both financial reporting and tax purposes?
Perpetual and Periodic Inventory Systems Records of the Genesis Corporation reveal the following information about inventory during the year.
1 Jan
Beginning inventory
1,000 units
@ $10
15 Mar
Purchase of inventory
3,500 units
@ $12
21 Jul
Sale of inventory
4,000 units
12 Sep
Purchase of inventory
1,600 units
@ $14
31 Oct
Sale of inventory
1,200 units
The company’s accountant is trying to decide whether to determine Cost of Goods Sold using the perpetual inventory system (calculating Cost of Goods Sold after every sale) or the periodic inventory system (calculating Cost of Goods Sold at the end of the year only). Assume the company uses the LIFO method for inventory costing.
Required Using the information given above, answer each of the following questions.
A. How many units have been sold? How many units remain in ending inventory?
B. What is Cost of Goods Sold using the perpetual method? The periodic method? What is the cost of ending inventory for each method?
C. Is there a difference in net income for each method? Why? (Assume for purposes of this question that Sales Revenue is $85,000 and all other expenses are $5,600.)
D. What are the advantages of using perpetual? Using periodic?
Return based Bonus, Ethics, and Accounting Standards Employees of the divisions of JX Controls, Inc. receive a bonus of 4% of their salary in any year in which the divisional return on assets is above 10%. Toward the end of 2004, accountants for the fire alarm division projected the following year end numbers:
Sales
$1,230,000
Cost of goods sold*
758,000
Other expenses†
322,000
Total divisional assets
1,590,000
At a meeting of divisional managers, Susan Torres, divisional vice president, told the group, “We’ve never received the bonus, although several other divisions have. Our employees work just as hard, and many of them really need the extra money for their families; I’d like us to get the bonus for them, as well as for ourselves. What ideas do you have for pulling it off?”
A variety of ideas were raised:
• “Let’s do what we can about sales. We have an order for $40,000 in goods to be shipped in early January; could we get those out the door in December, and add that gross margin to this year’s numbers?”
• “Sure—good idea. We might even accidentally overship by 20% and record the extra in this year’s sales.”
• “Could we slow down a bit on paying our bills? Wouldn’t a few suppliers be willing to wait until January—maybe for about $50,000?”
• “We’ve got that old forming machine that hasn’t been used for a year; it’s really useless. It’s on the books at $60,000 and is 70% depreciated, but it’s worth only about $3,000 as scrap. Have we written it down?”
• “The projection includes that new $90,000 bending machine that just came in. We should have delayed ordering it—but we haven’t booked it. Could we forget to record the machine and the payable until January?”
Required Write a short report reacting to the meeting. Determine which proposals would both be in accordance with accounting standards and actually raise return on assets. Calculate return on assets for the current projection, and with the inclusion of those measures that meet these two tests. Also include your thoughts about the advantages and disadvantages of such a bonus system.
Bonsai Company, a wholesaler of Asian foods, reported the following transactions for 2004:
1. Purchased $400,000 of merchandise inventory on credit.
2. Sold goods priced at $750,000 on credit.
3. The cost of merchandise sold to customers was $388,000.
4. Paid $384,000 to suppliers of merchandise.
5. Received $720,000 in cash from customers.
6. Granted $17,000 of sales discounts to customers for payment within the discount period.
7. Estimated that $10,000 of the year’s credit sales would be uncollectible.
8. Wrote off $8,000 of accounts as uncollectible.
Required Using the format shown in this chapter, record each of the transactions and determine the amount of net income and net operating cash flow associated with these transactions.
At December 31, 2004, the general ledger of Hoffman Electric had the following account balances. All adjusting entries (except for income taxes at 35%) have been made. The company had 10,400 shares of common stock outstanding during the year.
Accounts payable
$8,950
Equipment
$80,300
Accounts receivable
14,970
Gain on sale of land
4,800
Accrued liabilities
21,000
Interest expense
1,420
Accumulated depreciation
15,300
Merchandise
18,465
Advertising expense
9,968
Land
30,000
Cash
9,530
Retained earnings*
57,984
Common stock
36,000
Sales revenue
260,772
Cost of goods sold
102,690
Utilities expense
9,002
Depreciation expense
13,510
Wages expense
59,780
Prepare an income statement in good form. (Hint: See Exhibit 1.)
An excerpt from the income statement from the 2001 annual report of Alcoa, Inc. is provided below.
For the year ended December 31,
2001
(In millions except share amounts)
Revenues
Sales
$22,859
Other income, net
308
23,167
Costs and expenses
Cost of goods sold
17,857
Selling, general, administrative, and other expenses
1,276
Research and development expenses
203
Provision for depreciation, depletion, and amortization
1,253
Interest expenses
371
Other expenses
566
21,526
Earnings
Income before taxes on income
1,641
Provision for taxes on income
525
Income from operations
$1,116
Minority interests’ share
208
Net income
$908
Earnings per common share
$1.06
Briefly explain each item presented on the income statement. (Minority interest may be ignored if you are not studying the Other Topics section at the end of the chapter.) How much gross profit and operating income did Alcoa report for 2001?
For each of the following transactions of Yeats Machinery, indicate in which month or months the related revenue or expense should appear in the monthly income statement, and why.
a. In January, the firm receives an order for a $200,000 machine, along with a 30% cash deposit. The machine is manufactured in March and April, and is delivered to the customer on April 16. The remainder of the price is collected in May.
b. Components to be used in manufacturing the above machine are received in February and paid for in March.
c. Workers are paid for the work on the machine in April and May. Quarterly payments for their health insurance are made in June. Workers also will receive pension benefits at some point because of the work they did during this period. (Hint: Health insurance and pension benefits are part of the cost of labor.)
d. The company estimates there is a 5% chance that it will have to replace parts of the machine during the two year warranty period.
Geyser Company began operations in 2004. It had credit sales of $4 million and cash sales of $1 million. The chief accountant decided to estimate doubtful accounts expense at 5% of total credit sales. During the year, $3.5 million of the credit sales were collected from customers and by the end of the year, $150,000 had been written off as uncollectible.
At the end of the second year of operations, credit sales were $6 million and cash sales were $1.5 million. The accountant decided that it would be more accurate to base doubtful accounts expense on ending Accounts Receivable. Accordingly, it was estimated that the ending balance of Allowance for Doubtful Accounts should have a balance equal to 8% of Accounts Receivable. During the year, $5.4 million was collected from customers and $180,000 was written off as uncollectible. For each of the two years, determine the following amounts:
a. The ending balance of Accounts Receivable
b. The estimated Doubtful Accounts Expense
c. The ending balance in the Allowance for Doubtful Accounts
Sandoval, Inc. signed a $40 million contract to build a new office building. The company expected that the project would take about two and one half years. During the first year, the company incurred the following costs:
Raw materials
$4 million
Direct labor
6 million
Overhead (insurance, equipment rental, etc.)
2 million
At the end of the first year, management is very pleased with its construction to date. The costs incurred are consistent with the estimate that the project is 40% completed. Determine the amount of (a) revenue and (b) expense that the builder should report on its income statement at the end of the first year.
Measuring the Results of Investing Activities Accounting information is provided below for two companies in the hair care products industry.
Faucett Company
Danson Industries
(In millions)
2004
2003
2004
2003
Total assets
$33.80
$26.80
$84.40
$71.00
Sales
40.7
30.5
95.5
71.6
Net income
3.7
2.5
6.7
6
Required
A. Compute asset turnover, profit margin, and return on assets for each year and company. Also, compute asset growth for each company from 2003 to 2004.
B. Evaluate the performance of each company with respect to the other and also in terms of changes from 2003 to 2004. Identify reasons for the differences in performance.
Evaluating Investment Decisions The information below was reported by PepsiCo, Inc. in its 2001 annual report.
(In millions)
2001
2000
1999
Net sales
$26,935
$25,479
$25,093
Net income
2,662
2,543
2,505
Cash flow from operating activities
4,201
3,330
3,605
Cash invested in other companies
432
98
430
Cash purchases of plant assets
1,324
1,352
1,341
Cash flow from financing activities
1,919
2,648
1,828
Cash dividends paid
994
949
935
Total assets
21,695
20,757
19,948
Required Identify and evaluate PepsiCo’s investment decisions over the three years shown. Include in your analysis an examination of changes in efficiency and effectiveness.
Comparing Investment Performance The information below is for two companies in the same industry.
Griffith, Inc.
Johnson, Inc.
(In millions)
2005
2004
2005
2004
Sales
$8,223
$7,338
$9,430
$9,400
Net income
817
701
822
840
Total assets
7,250
6,490
8,347
8,350
Total liabilities
3,200
3,030
5,230
4,960
Market value
9,200
7,650
5,220
5,790
Required
A. Compute the asset turnover, profit margin, return on assets, and market to book value for each year and company. Also compute asset growth for each company from 2004 to 2005.
B. Compare the performances of the two companies over the two year period with respect to effectiveness and efficiency.
C. Explain what reasons you find for the differences in the market value of the two companies. Could there be additional explanatory factors that do not appear in these numbers?
Investing Decisions Regarding Product Lines The company for which you work has a significant investment in the stock of Star Beasts,
Inc. (SBI), which currently manufactures one kind of toy, a large and lovable stuffed monster.
SBI is considering expansion of its production facilities and would finance the expansion with long term borrowing at an expected interest rate of 10%. The market would seem to support the manufacture and sale of 20% more monsters at the current profit margin. The added facilities would cost approximately $3.4 million. Alternatively, SBI could add one of two new lines: a mechanical dragon or a game called Starship Troopers.
The numbers below indicate current operating results and projections for the effects of added facilities for manufacturing the new lines. The numbers do not include interest on the new facilities or the company’s 35% income tax rate.
(In thousands)
Current Operations
Addition of Dragons
Addition of Games
Sales
$3,300
$2,900
Operating expenses
2,450
2,300
Interest expense
?
?
Total assets
?
?
Capital expenditures
3,450
1,800
Required
A. In addition to showing the current income statement, prepare pro forma income statements for SBI under each of the three strategies: expanding manufacturing of the current product and adding each of the new lines.
B. Determine the return on assets for the current situation and for each of the three strategies.
C. Indicate under which strategy you would feel most confident about the value of your company’s investment, and explain why.
Evaluating Investment Decisions Creative Technology, Inc. reported the following information in its 2004 annual report.
(In millions except EPS)
Total Assets
Long Term Debt
Additions to Plant Assets
Net Income
Earnings per Share
2004
$31,471
$702
$4,032
$6,068
1.73
2003
28,880
448
4,501
6,945
1.93
2002
23,735
728
3,024
5,157
1.45
2001
17,504
400
3,550
3,566
1.01
2000
13,816
392
2,441
2,288
0.65
Required Using appropriate accounting ratios discussed in this chapter and any other ratios you think are helpful, evaluate the firm’s investment decisions for the period from 2000 to 2004.
Analyzing Ability to Meet Debt Payments Sporting Life, Inc., is a large retail chain of sporting goods stores. In a recent annual report, the following information was presented.
(In millions)
2004
2003
2002
Sales
$15,833
$15,668
$15,229
Operating income
1,455
1,341
893
Net income
662
536
266
Interest expense
304
418
499
Total assets
13,464
13,738
14,264
Long term debt
3,057
3,919
4,606
Shareholders’ equity
5,709
5,256
4,669
Cash provided by operating activities
1,690
1,573
1,220
Cash (used) by investing activities
445
318
650
Cash provided (used) by financing activities
1,080
1,262
594
Cash for investing activities was used primarily for property and equipment purchases. Cash used by financing activities was primarily to pay off long term debt and acquire treasury stock.
Required
A. Assume that you work for an investment firm that has an opportunity to invest in notes that are part of Sporting Life’s long term debt. Write a short report in which you analyze the firm’s ability to meet its debt payments, based on the information given.
B. Prepare a list of the most important additional pieces of information you would want before making a final decision about the investment. This list should include some accounting information; it might also include nonaccounting and nonquantitative items.
Assessing Credit Worthiness Year end financial information is provided below for two companies that make baseball caps.
Cobb Industries
Cobb Industries
(In millions)
2004
2003
2004
2003
Property, plant, and equipment
$283
$314
$171
$162
Total assets
392
424
259
246
Current liabilities
67
74
69
63
Long term debt
261
264
100
104
Stockholders’ equity
64
86
90
79
Asset impairment charge
18
—
—
—
Operating income
5
7
24
19
Interest expense
23
24
8
7
Required Study the information provided. If you were a creditor of these companies, would you be concerned about the ability of either company to repay its debts? Explain your answer.
Excel in Action The Book Wermz reported sales for 2005 of $6,230,000. Cost of goods sold was 55% of sales, and operating expenses were $2,155,000. Interest expense was $190,000. Income taxes were 35% of pretax income. Total assets at the end of 2005 were $5,623,000.
Required Use the information provided to produce an income statement for The Book Wermz for the year ended December 31, 2005. Enter appropriate captions for the statement at the top of the spreadsheet and appropriate captions in column A. Enter amounts in column B. Use equations to calculate subtotals and totals. Calculate cost of goods sold as sales = 0.55 and income taxes as pretax income = 0.35.
Following the income statement, enter the total assets data and calculate asset turnover, profit margin, and return on assets. Enter captions in column A and calculations in column B. Use cell references to the income statement and total assets in these calculations. Suppose that the company’s management believes that it can increase sales by reducing product prices. Cutting the prices relative to the costs of the goods sold would increase the ratio to 60%, but is expected to increase total sales to $7 million. Operating expenses and interest expense are relatively fixed and would not be affected by these changes. Total assets also would not be affected. In column C calculate the effects of the changes on the company’s income statement and financial ratios. Copy the data from column B to column C and make changes as needed. Would the pricing change be advantageous to the company? Another alternative for the company is to raise prices relative to cost of goods sold and significantly increase advertising. The increase in prices would reduce cost of goods sold to 50% of sales. The additional advertising expenses would increase operating expenses to $3 million.
Total sales are expected to increase to $7.5 million. Interest expense and total assets would not be affected by these changes. In column D calculate the effects of the changes on income and the financial ratios. Would the company benefit from these changes?
Company A and Company B are similar in size and in many other respects. The companies reported the following net cash flow from (used for) investing activities in their 2005 annual reports.
(In millions)
2005
2004
2003
Company A
$460
$350
$265
Company B200
200
35
80
From this information, you would expect
a. Company A to be growing more rapidly than Company B.
b. Company B to be growing more rapidly than Company A.
c. Company B to have better investment alternatives than Company A.
d. Company A to pay higher dividends than Company B.
Evaluating Investment Decisions Appendix B of this book contains a copy of the 2002 annual report of General Mills, Inc.
Required Review the annual report and write a short report in which you cover each of the following:
A. What major investing decisions did the company make from 2000 to 2002? Include decisions about disposing of as well as acquiring assets. (Hint: See note 2 to the financial statements, as well as the statement of cash flows.)
B. Evaluate the company’s growth rate for total assets and net income from 2000 to 2002. (Hint: See the six year financial summary.)
C. Compute return on assets, asset turnover, and profit margin for the company from 2000 to 2002. Does it appear that the company has made beneficial investing decisions?
Analysis of an Acquisition You are a financial analyst with a major corporation, High Hopes Company. You have been assigned the task of evaluating a potential acquisition candidate, Roll the Dice, Inc. Selected accounting information for the two companies is presented on the next page. Information for 2003 and 2004 reports actual company results. Results for 2005 are projected from information available at the beginning of the year.
(In millions)
2005
2004
2003
High Hopes Company
Depreciation and amortization expense
$13.40
$13.10
$11.60
Operating income
46.3
42.7
37.5
Interest expense
4.9
5.1
5.5
Provision for income taxes
14.1
11.8
11
Net income
27.3
25.8
21
Total assets
305.7
292.1
274.8
Total liabilities
125.9
128
135.2
Total stockholders’ equity
179.8
164.1
139.6
Net cash flow from operating activities
40.4
38.5
32.8
Net cash flow used for investing activities
14.1
12.8
9.8
Net cash flow used for financing activities
25.3
25.7
23
Roll the Dice, Inc.
Depreciation and amortization expense
$5.40
$5.20
$4.50
Operating income
22.8
19.3
12.9
Interest expense
3.7
3.5
3
Provision for income taxes
6.5
4.7
4.2
Net income
12.6
11.1
5.7
Total assets
114.3
111
93.4
Total liabilities
35.8
33.2
31.8
Total stockholders’ equity
78.5
77.8
73.5
Net cash flow from operating activities
18.7
16.4
14.6
Net cash flow used for investing activities
13.7
7.9
18.3
Net cash flow from (used for) financing activities
4.5
8.6
3.8
The acquisition, if it were to occur, would result in High Hopes purchasing all of the common stock of Roll the Dice at a price of $130 million. To finance the acquisition, High Hopes plans to issue $130 million of long term debt at 10.7% annual interest. The debt principal would be repaid in equal installments over 10 years. The interest would be paid annually on the unpaid principal. The fair market value of Roll the Dice’s identifiable assets is $107 million. The fair market value of its liabilities is $35.8 million. Goodwill from the acquisition will not be amortized. There are no intercompany transactions between High Hopes and Roll the Dice. Assume that High Hopes’ income tax rate is 34%.
Required Prepare a summary pro forma income statement and statement of cash flows for High Hopes for 2005, assuming it acquires Roll the Dice at the beginning of 2005. What recommendation would you make to High Hopes’ management concerning the acquisition?
At the end of its most recent fiscal year, Shangri La Company owned the following investments.
Investment
Historical Cost
Fair Market Value
A
$650,000
$765,000
B
840,000
730,000
Other assets had a book value of $2.4 million and liabilities had a book value of $2.8 million. Shangri La’s net income for 2004 was $280,000. If the company sold investment A at the end of the year for cash, what effect would the sale have on its financial statements and return on assets (ignoring the effect of income taxes)? Assume that assets are reported on the financial statements at historical cost. What effect would the sale of investment B have on the company’s financial statements and return on assets? Compare these amounts to those that would be reported if no investments were sold. Does this example help explain why mark tomarket accounting is often required by GAAP? Discuss.
Selected financial information is reported below for two companies in the computer manufacturing business. The information was taken from the firms’ 2001 annual reports.
(In millions)
Compaq
IBM
Plant assets, at cost
$7,098
$38,395
Depreciation expense
1,036
4,195
Net cash outflow for plant assets
927
4,495
a. Compute the ratio of depreciation expense to plant assets at cost for both firms. What do your results suggest?
b. Compute the ratio of cash invested for plant assets to plant assets at cost for both firms. What do your results suggest?
The following information is for McDonald’s Corporation from its 2001 annual report.
(In millions)
2001
2000
1999
Revenues
$14,870
$14,253
$13,259
Net income
1,637
1,977
1,948
Total assets
22,535
21,684
20,983
Evaluate McDonald’s Corporation’s investing decisions by computing and analyzing its asset turnover, profit margin, and return on assets for 1999 through 2001
The following information was reported by McDonald’s Corporation in its 2001 annual report.
(In millions)
2001
2000
1999
Cash flow from operating activities
$2,688
$2,752
$3,009
Total assets
22,535
21,684
20,983
Evaluate McDonald’s Corporation’s investing decisions by computing the ratio of cash flow from operating activities to total assets for 1999 through 2001. Compare the cash flow ratio with return on assets from E12 9. What do you conclude, given this information?
Bumblebee Enterprises is considering adding another product line. Below are results from last year and pro forma (expected) results with the addition of the new line. Little change in sales from the current product lines is expected.
(In millions)
Last Year
Pro Forma
Sales
$260
$322
Net income
24
32
Total assets
300
372
Analyze the changes in effectiveness, efficiency, and return on assets that would be expected if the product line were added. Would you recommend addition of the product line?
The following information is available for Cello Company:
2005
2004
2003
Sales
$15,000
$8,000
$4,000
Net income
5,250
2,800
1,200
Average assets
30,000
20,000
10,000
Calculate the return on assets, profit margin, and asset turnover for each year and discuss the reasons for the change in return on assets over the three years.
Winger, Inc. is in the business of renting medical equipment for home health care. New government standards for lifts for disabled patients have rendered some equipment obsolete.
Abdullah Company reported the following information on its statement of cash flows.
(In millions)
2005
2004
2003
Net cash provided by operating activities
$3,195
$2,869
$2,688
Net cash from (used by) investing activities:
Capital expenditures
2,661
1,358
523
Sales of equipment and property
293
305
257
Investments in other companies
272
0
0
Other
392
627
924
Total investing activities
($2,248)
($1,680)
($1,190)
Net cash from (used by) financing activities:
Payments on long term debt
547
648
2,130
Repurchase of common stock
994
740
0
Other
627
200
614
Total financing activities
($914)
($1,188)
($1,516)
Interest expense for the past three years has been $372, $420, and $514. The company does not pay dividends. What information about the company’s future prospects is communicated by its investing and financing activities during this period? Does the company appear to be a good prospect for new debt financing to be spent on additional capital assets?
Determining Investment Strategy for a New Company You have graduated with a business degree, and you have worked for three years for a small management consulting firm. Ivan Steeger (1352 Bull Run Road, Milltown, OR 97111) is a client who has been involved with several businesses in the past. He expects to be the major provider of equity capital for a new mail order low fat cookie business. His co owners, who have baking expertise and a talent for developing recipes, will run the business. The owners are about to meet to determine what equipment they will purchase for the business. Ivan gives you the following information about the business and their plans:
• Ivan will be providing about 25% of the financing; the remainder will be debt. Ivan will probably have to give his personal guarantee for much of the debt. The exact amount of debt will depend on the price of the equipment they decide to purchase.
• They expect business growth of about 20% for each of the first five years.
• All of the equipment has an expected life of at least five years. They will definitely purchase mixing and baking equipment. They must decide whether to add equipment that will shape cookies automatically, or hire employees to do the shaping.
• They also must decide what capacity they prefer in their initial equipment purchase. Smaller capacity equipment would handle their expected demand for the first two years, operating eight hours a day. Equipment with twice the capacity would cost approximately 50% more.
Ivan asks for recommendations about discussion items for the meeting.
Required Write Ivan a letter in which you suggest major issues the owners should consider in making decisions about investments in equipment. You can assume that Ivan has some understanding of business terminology.
The Effect of Investment Strategy and Operating Leverage on Risk and Profits – Following is a set of pro forma (or projected) income statements for a company. The columns labeled A are projected results for the company if it follows Strategy A. The columns labeled B are projected results for the company if it follows Strategy B.
Low sales
Medium sales
High sales
A
B
A
B
A
B
Sales
$3,000
$3,000
$4,000
$4,000
$5,000
$5,000
Cost of sales
180
180
240
240
300
300
Depreciation
315
450
355
450
395
450
Wages expense
1,300
1,500
1,600
1,500
1,800
1,500
Other operating expenses
1,000
1,000
1,000
1,000
1,000
1,000
Operating income
205
130
805
810
1,505
1,750
Income tax (expense) or savings
72
46
282
284
527
613
Net income
$133
($84)
$523
$526
$978
$1,137
Required Study the information given and discuss each of the following.
A. The comparative risk of Strategy A versus Strategy B, as shown in the projected net income results
Evaluating the Effects of Operating Leverage on Profits Yamhill County currently provides garbage removal services for two of the four small towns within its boundaries. In addition, it provides garbage removal services for residents who live in outlying rural areas. Each town has the option of contracting for garbage removal service from the county or providing service itself. Garbage volume and the resulting revenue from each town served is approximately the same; garbage volume for those who live in outlying rural areas is approximately that of two towns. Under the current situation, the following revenues and costs are incurred.
Revenue from garbage removal services
$2,000,000
Fixed expenses (don’t change when revenues change) Variable expenses (change proportionately when sales change):
600,000
Wages
1,100,000
Truck maintenance
100,000
The Yamhill County commissioners are considering purchase of new garbage trucks that lift and crush the garbage more efficiently. This would double the fixed expenses and cut the existing variable expenses in half.
Required
A. Prepare a three column pro forma income statement for the Yamhill County garbage service assuming the existing equipment continues in use. Show (1) the amount of projected net income if only outlying rural areas are served, (2) income if outlying rural areas plus those of two towns are served, and (3) income if outlying rural areas and four towns are served. Use the following format.
Outlying rural areas only
Outlying rural areas plus two towns
Outlying rural areas plus four towns
Revenues
Fixed expenses
Variable expenses
Net income
B. Using the same format, prepare another three column pro forma income statement showing garbage service with the new equipment under each of the three income situations listed in the first requirement.
C. Explain the effects that changing to new trucks could have on Yamhill County’s profits and risks from the garbage service.
Comparing Operating Leverage Information is provided below from the annual reports of two manufacturing companies operating in different industries.
Solution Software, Inc.
Fashion Clothing Co.
(In millions)
Sales
Earnings
Sales
Earnings
2001
$4,600
$1,150
$3,800
$300
2002
6,000
1,500
4,800
400
2003
8,700
2,200
6,500
550
2004
11,400
3,500
9,200
800
2005
14,500
4,500
9,500
850
Required Prepare a graph to illustrate the relationship between each company’s earnings and its sales over the five years. Which company has the higher operating leverage? What effect does operating leverage have on the companies’ operating income?
Operating Leverage and Risk Financial statement information is presented below for Hillary Corporation, a producer of mountain climbing gear. The company expects sales to increase by about 20% in 2004.
(In millions)
2003 Actual
2004 Expected
Sales
$692
$830
Cost of goods sold
462
554
Operating expenses
206
247
Operating income
24
29
Interest expense
5
5
Pretax income
19
24
Income taxes
7
8
Net income
$12
$16
Hillary’s management is considering automating much of the company’s production process. The automation would result in about half of the company’s cost of goods sold being fixed. Currently, most of these costs vary in proportion to sales, as shown in the financial numbers presented above.
Required
A. Assume that half ($231 million) of Hillary’s cost of goods sold in 2003 is fixed and that the other half increases in proportion to sales, an increase of 20%. Compute the company’s expected cost of goods sold.
B. Using the same assumptions as part A, compute expected net income for 2004. Assume that income taxes are 35% of pretax income. Round to the nearest million.
C. Compare your results with those presented above, which assume that cost of goods sold varies in proportion to sales. What effect would the automation have on Hillary’s profitability? What effect would it have on the company’s risk? Explain your answer.
Assessing the Effects of Operating Leverage Information is provided below from the financial statements of two companies for 2004.
2004
Jekle
Hyde
Total assets
$30,000
$80,000
Total debt
10,000
50,000
Total equity
20,000
30,000
Sales
28,000
75,000
Operating expense
20,000
60,000
Operating income
8,000
15,000
Interest expense
800
5,000
Pretax income
7,200
10,000
Income taxes (30%)
2,160
3,000
Net income
5,040
7,000
Jekle’s operating expenses include fixed costs of $5,000. Hyde’s operating expenses include fixed costs of $50,000. All other operating expenses vary in proportion to sales for both companies. Assume that during 2005 sales for both companies increased by 20% from the amount reported, to $33,600 for Jekle and to $90,000 for Hyde.
Required
A. Compute the net income Jekle and Hyde would report for 2005 if sales increased by 20%.
B. Compute return on assets for Jekle and Hyde in 2004 and 2005, assuming the increase in sales and no change in total assets.
C. Explain why the increase in sales would affect Jekle and Hyde differently and explain which company is riskier.
Comparing Cash Flows Cash flow information is provided below for two companies in the health care products industry. Cash outflows are shown in parentheses.
(In millions)
2001
2000
1999
Total
Johnson & Johnson
Operating activities
$8,864
$6,903
$5,920
$21,687
Investing activities
4,093
2,665
3,093
9,851
Financing activities
5,251
2,425
2,347
10,023
Warner Lambert
Operating activities
$9,080
$7,687
$6,131
$22,898
Investing activities
4,312
3,641
2,817
10,770
Financing activities
5,071
3,447
3,869
12,387
Required Analyze the companies’ cash flows for 1999 to 2001 and for the three years in total. Explain how the two companies compare in terms of their cash flow trends.
Assessing Asset and Investment Strategy Widgets, Inc. and Gizmos, Inc. both manufacture accessories for computer users. The table below shows their investment policies and operating results for the past two years.
Widgets, Inc.
Gizmos, Inc.
(In thousands)
2004
2003
2004
2003
Plant and equipment
$2,400
$2,200
$4,300
$4,400
Accumulated depreciation
600
580
2,200
1,900
Total assets
5,000
4,300
8,000
8,100
Net income
432
320
615
140
Depreciation
320
290
520
541
Cash flow from operations
710
644
105
376
Cash flow from investing activities
305
274
205
56
New investment in plant and equipment
316
280
180
220
Required Explain what the preceding numbers tell you about the two companies’ assets and investment policies. Include any information you find that would indicate financial problems within either company.
Comparing Cash Flows Cash flow information is provided below for two companies in the food products industry. Cash outflows are shown in parentheses.
(In millions)
2001
2000
1999
Total
Earthgrains Co.
Operating activities
$165
$107
$130
$402
Investing activities
123
742
216
1,081
Financing activities
39
608
93
662
Campbell Soup Co.
Operating activities
$1,106
$1,165
$954
$3,225
Investing activities
1,122
204
322
1,648
Financing activities
15
943
636
1,564
Required Analyze the companies’ cash flows for 1999 through 2001 and for the three years in total. Explain how the two companies compare in terms of their cash flow trends.
Comparing Investment Activities Information is provided below from the 2001 annual reports of PepsiCo, Inc. and The Coca Cola Company.
(In millions except per share amounts)
PepsiCo
Coca Cola
Current assets
$5,853
$7,171
Investments and other assets
4,125
8,214
Plant assets, at cost
12,180
7,105
Plant assets, net
6,876
4,453
Intangibles, net
4,841
2,579
Total assets
21,695
22,417
Current liabilities
4,998
8,429
Long term debt
2,651
1,219
Shareholders’ equity
8,648
11,366
Net income
2,662
3,969
Net sales
26,935
20,092
Interest expense
219
289
Depreciation and amortization
1,082
803
Net cash provided by operating activities
4,201
4,110
Net cash from (used) in investing activities
2,637
1,188
Net cash from (used) in financing activities
1,919
2,830
Earnings per share
1.51
1.6
Market value of equity
86,475
117,226
Required Use appropriate accounting ratios discussed in this chapter and any other ratios you think are helpful to compare the investing activities and performances of the two companies for 2001. What important differences exist in the investing and financing activities of the companies? How do these differences affect the risk and return of the companies? How would you expect these differences to affect the market to book value and book value to cash flow from operating activities ratios of the two companies?
Assignment 1.pdf
L8 Ch 15 16 C….ppt
Accounting 1 ….xlsx
BULAW 5916 As….docx
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