Inventory methods Express Lane, Inc., a regional convenience store chain, maintains milk inventory by the gallon. The first month’s milk purchases and sales at its Freeport, FL, location follows:
Nov
2
1 gallon @ $2.00 each
6
2 gallons @ $2.10 each
13
2 gallons @ $2.20 each
14
The store sold 4 gallons of milk to a customer.
Requirement
1. Describe which costs would be sold and which costs would remain in inventory. Then, identify the amount that would be reported in inventory on November 15 using
Measuring and journalizing inventory and cost of goods sold in a perpetual system—FIFO Golf Haven carries an inventory of putters and other golf clubs. Golf Haven uses the FIFO method and a perpetual inventory system. The sales price of each putter is $128. Company records indicate the following for a particular line of Golf Haven’s putters:
Date
Item
Quantity
Unit Cost
Nov
1
Balance
17
$68
6
Sale
7
8
Purchase
20
$74
17
Sale
20
30
Sale
4
Requirements
1. Prepare a perpetual inventory record for the putters. Then determine the amounts Golf Haven should report for ending inventory and cost of goods sold using the FIFO method.
2. Journalize Golf Haven’s inventory transactions using the FIFO method.
Journalizing perpetual inventory transactions—cost of sales given Accounting records for Josh’s Shopping Bags yield the following data for the year ended May 31, 2012:
Inventory, May 31, 2011
$8,000
Purchases of inventory (on account)
46,000
Sales of inventory – 81% on account; 19% for cash (cost $38,000)
76,000
Inventory, May 31, 2012
?
Requirements
1. Journalize the inventory transactions for the company using the data given.
2. Report ending inventory on the balance sheet, and sales, cost of goods sold, and gross profit on the income statement.
Applying the lower of cost or market rule to inventories Eagle Resources, which uses the FIFO method, has the following account balances at May 31, 2012, prior to releasing the financial statements for the year:
Inventory
Cost of goods sold
Sales revenue
Beg Bal
12,500
End Bal
13,000
Bal
69,000
Bal
118,000
Eagle has determined that the replacement cost (current market value) of the May 31, 2012, ending inventory is $12,800.
Requirements
1. Prepare any adjusting journal entry required from the information given.
2. What value would Eagle report on the balance sheet at May 31, 2012, for inventory?
Applying the lower of cost or market rule to inventories Naturally Good Foods reports inventory at the lower of average cost or market.Prior to releasing its March 2012 financial statements, Naturally’s preliminary income statement, before the year end adjustments, appears as follows:
NATURALLY GOOD FOODS
Income Statement (partial)
For the year ended March 31, 2012
Sales revenue
$117,000
Cost of goods sold
45,000
Gross profit
$72,000
Naturally has determined that the replacement cost of ending inventory is $17,000. Cost is $18,000.
Requirements
1. Journalize the adjusting entry for inventory, if any is required.
2. Prepare a revised income statement to show how Naturally Good Foods should report sales, cost of goods sold, and gross profit.
Correcting an inventory error—two years Great Foods Grocery reported the following comparative income statement for the years ended June 30, 2012 and 2011:
GREAT FOODS GROCERY
Income Statements
Years Ended June 30, 2012 and 2011
2012
2011
Sales revenue
$ 139,000
$ 120,000
Cost of goods sold:
Beginning inventory
$13,000
$12,000
Net purchases
76,000
70,000
Cost of goods available
$89,000
$82,000
Ending inventory
(17,000)
(13,000)
Cost of goods sold
72,000
69,000
Gross profit
$ 67,000
$ 51,000
Operating expenses
23,000
18,000
Net income
$44,000
$ 33,000
During 2012, Great Foods discovered that ending 2011 inventory was overstated by $4,500.
Requirements
1. Prepare corrected income statements for the two years.
2. State whether each year’s net income—before your corrections—is understated or overstated and indicate the amount of the understatement or overstatement.
Estimating ending inventory by the gross profit method Deluxe Auto Parts holds inventory all over the world. Assume that the records for one auto part show the following:
Beginning inventory
$ 220,000
Net purchases
800,000
Net sales
1,100,000
Gross profit rate
45%
Suppose this inventory, stored in the United States, was lost in a fire.
Requirement
1. Estimate the amount of the loss to Deluxe Auto Parts. Use the gross profit method.
Accounting for inventory using the perpetual system—LIFO, and journalizing inventory transactions Fit World began January with an inventory of 80 crates of vitamins that cost a total of $4,000. During the month, Fit World purchased and sold merchandise on account as follows:
Purchase 1
140 crates @ $ 55
Sale 1
160 crates @ $ 100
Purchase 2
160 crates @ $ 60
Sale 2
170 crates @ $ 110
Fit World uses the LIFO method. Cash payments on account totaled $5,000. Operating expenses for the month were $3,300, with two thirds paid in cash, and the rest accrued as Accounts payable.
Requirements
1. Which inventory method most likely mimics the physical flow of Fit World’s inventory?
2. Prepare a perpetual inventory record, using LIFO cost, for this merchandise.
Applying the lower of cost or market rule to inventories Richmond Sporting Goods, which uses the FIFO method, has the following account balances at August 31, 2012, prior to releasing the financial statements for the year:
Inventory
Cost of goods sold
Sales revenue
Bal
14,500
Bal
67,000
Bal
117,000
Richmond has determined that the replacement cost (current market value) of the August 31, 2012, ending inventory is $13,500.
Requirements
1. Prepare any adjusting journal entry required from the information given.
2. What value would Richmond report on the balance sheet at August 31, 2012, for inventory?
following data. In early 2013, auditors found that the ending inventory for 2010 was understated by $6,000 and that the ending inventory for 2012 was overstated by $7,000. The ending inventory at December 31, 2011, was correct.
2012
2011
2010
Net sales revenue
$210,000
$162,000
$169,000
Cost of goods sold:
Beginning inventory
$ 20,000
$ 27,000
$ 41,000
Net purchases
140,000
108,000
98,000
Cost of goods available
$160,000
$135,000
$139,000
Correcting inventory errors over a three year period Evergreen Carpets’ books show the Ending inventory
(29,000)
(20,000)
(27,000)
Cost of goods sold
131,000
115,000
112,000
Gross profit
$ 79,000
$ 47,000
$ 57,000
Operating expenses
53,000
18,000
24,000
Net income
$ 26,000
$ 29,000
$ 33,000
Requirements
1. Prepare corrected income statements for the three years.
2. State whether each year’s net income—before your corrections—is understated or overstated and indicate the amount of the understatement or overstatement.
Accounting for inventory using the perpetual system—LIFO and journalizing inventory transactions Health World began January with an inventory of 50 crates of vitamins that cost a total of $1,000. During the month, Health World purchased and sold merchandise on account as follows:
Purchase 1
100 crates @ $ 25
Sale 1
130 crates @ $ 40
Purchase 2
90 crates @ $ 30
Sale 2
100 crates @ $ 50
Health World uses the LIFO method. Cash payments on account totaled $5,500. Operating expenses for the month were $3,000, with two thirds paid in cash and the rest accrued as Accounts payable.
Requirements
1. Which inventory method most likely mimics the physical flow of Health World’s inventory?
2. Prepare a perpetual inventory record, using LIFO cost, for this merchandise.
Accounting for inventory using the perpetual system—FIFO, LIFO, and average cost; comparing FIFO, LIFO, and average cost Ornamental Iron Works began January with 45 units of iron inventory that cost $24 each. During January, the company completed the following inventory transactions:
Units
Unit Cost
Unit Sale Price
Jan
3 Sale
35
$51
8 Purchase
70
$32
21 Sale
65
$73
30 Purchase
25
$47
Requirements
1. Prepare a perpetual inventory record for the inventory using FIFO.
2. Prepare a perpetual inventory record for the inventory using LIFO.
3. Prepare a perpetual inventory record for the inventory using average cost.
4. Determine the company’s cost of goods sold for January using FIFO, LIFO, and average cost.
5. Compute gross profit for January using FIFO, LIFO, and average cost.
Journalizing purchase and sale transactions—perpetual inventory Consider the following transactions that occurred in September 2012 for Aquamarines, Inc.
Sep 3
Purchased inventory on terms 1/15, n/eom, $5,000.
4
Purchased inventory for cash of $1,700.
6
Returned $500 of inventory from September 4 purchase.
8
Sold goods on terms of 2/15, n/35 of $6,000 that cost $2,640.
10
Paid for goods purchased September 3.
12
Received goods from September 8 sale of $400 that cost $160.
23
Received payment from September 8 customer.
25
Sold goods to Smithsons for $1,100 that cost $400. Terms of n/30
were offered. As a courtesy to Smithsons, $75 of freight was added to the invoice for which cash was paid directly to UPS by Aquamarines, Inc.
29
Received payment from Smithsons.
Requirement
1. Journalize September transactions for Aquamarines, Inc. No explanations are required.
Journalizing purchase and sale transactions—perpetual system The following transactions occurred between Belvidere Pharmaceuticals and D & S, the pharmacy chain, during July of the current year:
Jul 6
D & S purchased $12,000 of merchandise from Belvidere on credit terms of 3/10, n/30, FOB shipping point. Separately, D & S paid a $200 bill for freight in. These goods cost Belvidere $3,600.
10
D & S returned $3,000 of the merchandise purchased on July 6. Belvidere accounted for the sales return and placed the goods back in inventory (Belvidere’s cost, $1,200).
15
D & S paid $6,000 of the invoice amount owed to Belvidere for the July 6 purchase, less the discount.
27
D & S paid the remaining amount owed to Belvidere for the July 6 purchase.
Requirements
1. Journalize these transactions on the books of D & S.
2. Journalize these transactions on the books of Belvidere Pharmaceuticals.
Preparing a multi step income statement and a classified balance sheet The accounts of Taylor Electronics Company are listed along with their balances before closing for the month ended March 31, 2012.
Interest revenue
$ 200
Accounts payable
$ 16,700
Inventory
45,100
Accounts receivable
33,600
Note payable, long–term
46,000
Accumulated depreciation
37,700
Salary payable
2,700
Retained earnings, Feb 28
38,600
Sales discounts
2,900
Dividends
20,000
Sales returns and allowances
7,500
Cash
8,000
Sales revenue
297,000
Cost of goods sold
162,300
Selling expense
38,200
Equipment
129,100
Supplies
6,000
General expenses
16,700
Unearned sales revenue
13,800
Common stock
15,500
Interest payable
1,200
Requirements
1. Prepare Taylor Electronics’ multi step income statement.
2. Prepare Taylor Electronics’ statement of retained earnings.
3. Prepare Taylor Electronics’ classified balance sheet in report form.
Preparing a multi step income statement and a classified balance sheet The accounts of Smith Electronics Company are listed along with their balances before closing for the month ended October 31, 2012.
Interest revenue
$ 500
Accounts payable
$ 16,900
Inventory
45,400
Accounts receivable
33,900
Note payable, long–term
47,000
Accumulated depreciation
38,100
Salary payable
3,400
Retained earnings, Sep 30
39,000
Sales discounts
2,700
Dividends
19,000
Sales returns and allowances
8,100
Cash
7,600
Sales revenue
296,500
Cost of goods sold
162,100
Selling expense
37,500
Equipment
130,900
Supplies
6,300
General expenses
16,200
Unearned sales revenue
13,800
Common stock
13,500
Interest payable
1,000
Requirements
1. Prepare Smith Electronics’ multi step income statement.
2. Prepare Smith Electronics’ statement of retained earnings.
3. Prepare Smith Electronics’ classified balance sheet in report form.
Preparing a multi step income statement and calculating gross profit percentage The records of Hill Tower Steak Company list the following selected accounts for the quarter ended September 30, 2012:
Interest revenue
$ 400
Accounts payable
$ 16,500
Inventory
45,700
Accounts receivable
33,900
Note payable, long–term
42,000
Accumulated depreciation
37,500
Salary payable
3,400
Retained earnings, Jun 30
38,900
Sales discounts
2,200
Dividends
18,500
Sales returns and allowances
8,400
Cash
8,100
Sales revenue
296,700
Cost of goods sold
162,400
Selling expense
37,500
Equipment
125,000
Supplies
6,000
General expenses
16,100
Unearned sales revenue
13,200
Common stock
14,000
Interest payable
1,200
Requirements
1. Prepare a multi step income statement.
2. M. Davidson, manager of the company, strives to earn gross profit percentage of at least 50% and net income percentage of 20%. Did Hill Tower achieve these goals? Show your calculations.
Journalizing purchase and sale transactions—perpetual inventory; making closing entries, and preparing financial statements This exercise continues the Lawlor Lawn Service, Inc., situation from of Lawlor Lawn Service has also begun selling plants that it purchases from a wholesaler. During June, Lawlor Lawn Service completed the following transactions:
Jun 2
Completed lawn service and received cash of $800.
5
Purchased 110 plants on account for inventory, $304, plus freight in of $15.
15
Sold 60 plants on account, $600 (cost $174).
17
Consulted with a client on landscaping design for a fee of $250 on account.
20
Purchased 120 plants on account for inventory, $384.
21
Paid on account, $400.
25
Sold 110 plants for cash, $990 (cost $337).
30
Recorded the following adjusting entries: Depreciation $30 Physical count of plant inventory, 30 plants (cost $96)
Requirements
1. Open the following selected T accounts in the ledger: Cash, Accounts receivable, Lawn supplies, Plant inventory, Equipment, Accumulated depreciation— equipment, Accounts payable, Salary payable, Common stock, Retained earning, Dividends, Income summary, Service revenue, Sales revenue, Cost of goods sold, Salary expense, Rent expense, Utilities expense, Depreciation expense—equipment, and Supplies expense.
2. Journalize and post the June transactions. Key all items by date. Compute each account balance, and denote the balance as Bal.
3. Journalize and post the closing entries. Denote each closing amount as Clo. After posting all closing entries, prove the equality of debits and credits in the ledger. 4. Prepare the June income statement of Lawlor Lawn Service. Use the singlestep format.
Journalizing purchase and sale transactions—perpetual inventory; making closing entries, and preparing financial statements Draper performs systems consulting. Draper has also begun selling accounting software. During January, Draper Consulting completed the following transactions:
Jan 2
Completed a consulting engagement and received cash of $7,800.
2
Prepaid three months office rent, $1,650.
7
Purchased 80 units software inventory on account, $1,680, plus freight in, $80.
18
Sold 40 software units on account, $3,500 (Cost $880).
19
Consulted with a client for a fee of $1,000 on account.
20
Paid employee salary, $2,055.
21
Paid on account, $1,760.
22
Purchased 240 units software inventory on account, $6,240.
24
Paid utilities, $250.
28
Sold 120 units software for cash, $4,680 (cost $2,960).
31
Recorded the following adjusting entries: Accrued salary expense, $685 Depreciation, $100 (Equipment, $30; Furniture, $70) Expiration of prepaid rent, $550 Physical count of inventory, 145 units, $3,770
Requirements
1. Open the following selected T accounts in the ledger: Cash, Accounts receivable, Software inventory, Prepaid rent, Accumulated depreciation, Accounts payable, Salary payable, Common stock, Retained earnings, Dividends, Income summary, Service revenue, Sales revenue, Cost of goods sold, Salary expense, Rent expense, Utilities expense, and Depreciation expense.
2. Journalize and post the January transactions. Key all items by date. Compute each account balance, and denote the balance as Bal.
3. Journalize and post the closing entries. Denote each closing amount as Clo. After posting all closing entries, prove the equality of debits and credits in the ledger.
4. Prepare the January income statement of Draper Consulting. Use the singlestep format.
Journalizing purchase and sale transactions—perpetual inventory; making closing entries, and preparing financial statements Shine King Cleaning has decided that, in addition to providing cleaning services, it will sell cleaning products. During December, Shine King completed the following transactions:
Dec 2
Purchased 600 units of inventory for $3,600 from Sparkle, Co., on terms, 3/10, n/20.
5
Purchased 400 units of inventory from Borax on terms 4/5, n/30. The total invoice was for $3,200, which included a $200 freight charge.
7
Returned 100 units of inventory to Sparkle from the December 2 purchase (cost $600).
9
Paid Borax.
11
Sold 350 units of goods to Happy Maids for $4,900 on terms 5/10, n/30. Shine King’s cost of the goods was $2,100.
12
Paid Sparkle.
15
Received 30 units with a retail price of $420 of goods back from customer Happy Maids. The goods cost Shine King $180.
21
Received payment from Happy Maids, settling the amount due in full.
28
Sold 200 units of goods to Bridget, Inc., for cash of $3,000 (cost $1,144).
29
Paid cash for Utilities of $350.
30
Paid cash for Sales commission expense of $225.
31
Recorded the following adjusting entries: Physical count of Inventory on December 31 showed 330 units of goods on hand, $2,541 Depreciation, $170 Accrued salary expense of $700 Prepared all other adjustments necessary for December
Requirements
1. Add any needed accounts to Shine King’s existing chart of accounts.
2. Journalize and post the December transactions. Key all items by date. Compute each account balance, and denote the balance as Bal.
3. Journalize and post the adjusting entries. Denote each adjusting amount as Adj. After posting all adjusting entries, prove the equality of debits and credits in the ledger.
4. Prepare the December multi step income statement, statement of retained earnings, and balance sheet for the company.
5. Journalize the December closing entries for the company.
Bill Hildebrand and Melissa Nordhaus opened Party Time T Shirts to sell T shirts for parties at their college. The company completed the first year of operations, and the owners are generally pleased with operating results as shown by the following income statement:
PARTY TIME T SHIRTS
Income Statement
Year Ended December 31, 2011
Net sales revenue
$350,000
Cost of goods sold
210,000
Gross margin
$140,000
Operating expenses:
Selling expense
40,000
General expense
25,000
Net income
$ 75,000
Hildebrand and Nordhaus are considering how to expand the business. They each propose a way to increase profits to $100,000 during 2012.
a. Hildebrand believes they should advertise more heavily. He believes additional advertising costing $20,000 will increase net sales by 30% and leave general expense unchanged.Assume that Cost of goods sold will remain at the same percentage of net sales as in 2011, so if net sales increases in 2012, Cost of goods sold will increase proportionately.
b. Nordhaus proposes selling higher margin merchandise, such as party dresses, in addition to the existing product line. An importer can supply a minimum of 1,000 dresses for $40 each; Party Time can mark these dresses up 100% and sell them for $80. Nordhaus realizes they will have to advertise the new merchandise, and this advertising will cost $5,000. Party Time can expect to sell only 80% of these dresses during the coming year.
Requirement
1. Help Hildebrand and Nordhaus determine which plan to pursue. Prepare a single step income statement for 2012 to show the expected net income under each plan.
Dobbs Wholesale Antiques makes all sales under terms of FOB shipping point. The company usually ships inventory to customers approximately one week after receiving the order. For orders received late in December, Kathy Dobbs, the owner, decides when to ship the goods. If profits are already at an acceptable level, Dobbs delays shipment until January. If profits for the current year are lagging behind expectations, Dobbs ships the goods during December.
Requirements
1. Under Dobbs’ FOB policy, when should the company record a sale?
2. Do you approve or disapprove of Dobbs’ manner of deciding when to ship goods to customers and record the sales revenue? If you approve, give your reason. If you disapprove, identify a better way to decide when to ship goods. (There is no accounting rule against Dobbs’ practice.)
Rae Philippe was a warehouse manager for Atkins Oilfield Supply, Co., a business that operated across eight Western states. She was an old pro and had known most of the other warehouse managers for many years. Around December each year, auditors would come to do a physical count of the inventory at each warehouse. Recently, Rae’s brother started his own drilling company, and persuaded Rae to “loan” him 80 joints of 5 inch drill pipe to use for his first well. He promised to have it back to Rae by December, but the well encountered problems and the pipe was still in the ground. Rae knew the auditors were on the way, so she called her friend Andy, who ran another Atkins warehouse. “Send me over 80 joints of 5 inch pipe tomorrow and I’ll get them back to you ASAP” said Rae. When the auditors came, all the pipe on the books was accounted for, and they filed a “no exception” report.
Requirements
1. Is there anything the company or the auditors could do in future to detect this kind of fraudulent practice?
2. How would this kind of action impact the financial performance of the company?
This case uses both the income statement (statement of operations) and the balance.It will help you understand the closing process of a business.
Requirements
1. Journalize closing entries for the revenues and expenses of 2009. Show all amounts in millions as in the financial statements. You may be unfamiliar with certain revenues and expenses, but treat each item on the income statement as either a revenue or an expense. For example, Net sales is the first revenue item. Other items you may be unfamiliar with are as follows: “Other operating expense (income), net” is shown in parentheses, so it should be treated as revenue. “Interest Income” should be treated as revenue. Although the amount shown for “Interest expense” is in parentheses, you may ignore those parentheses for this purpose and treat it similar to other expenses. “Other income (expense), net” is shown as a positive number, so it should be treated as revenue. The “provision for income taxes” should be treated as an expense. “Equity method investment activity, net of tax” is shown in parentheses, so it should be shown as an expense. In your closing entries, ignore all subtotals such as Gross profit, Total operating expenses, Income from operations, Total non operating income (expense), and Net income (loss).
2. Create a T account for the Income summary, post to that account, and then close the Income summary. How much was closed to Retained earnings? How is the amount that was closed to Retained earnings labeled on the income statement?
With a small team of classmates, visit one or more merchandising businesses in your area. Interview a responsible manager of the company to learn about its inventory policies and accounting system. Obtain answers to the following questions, write a report, and be prepared to make a presentation to the class if your instructor so directs.
Requirements
1. What merchandise inventory does the business sell?
2. From whom does the business buy its inventory? Is the relationship with the supplier new or longstanding?
3. What are the FOB terms on inventory purchases? Who pays the freight, the buyer or the seller? Is freight a significant amount? What percentage of total inventory cost is the freight?
4. What are the credit terms on inventory purchases—2/10, n/30, or other? Does the business pay early to get purchase discounts? If so, why? If not, why not?
5. How does the business actually pay its suppliers? Does it mail a check or pay electronically?
What is the actual payment procedure?
6. Which type of inventory accounting system does the business use—perpetual or periodic? Is this system computerized?
7. How often does the business take a physical count of its inventory? When during the year is the count taken? Describe the count procedures followed by the company.
8. Does the manager use the gross profit percentage and the rate of inventory turnover to evaluate the business? If not, show the manager how to use these ratios in decision making.
9. Ask any other questions your group considers appropriate.
Cost of goods sold in a periodic system Delta Electric, Co., uses the periodic inventory system. Delta reported the following selected amounts at May 31, 2012:
Completing the accounting cycle The trial balance of Road Runner Internet, Inc., at July 31, 2012, follows:
ROAD RUNNER INTERNET, INC.
Trial Balance
July 31, 2012
Balance
Account
Debit
Credit
Cash
$ 4,200
Accounts receivable
14,600
Prepaid rent
2,000
Supplies
1,600
Equipment
30,900
Accumulated depreciation
$ 3,900
Accounts payable
6,700
Salary payable
Unearned service revenue
5,400
Common stock
3,000
Retained earnings
22,800
Dividends
3,200
Service revenue
17,700
Salary expense
3,000
Rent expense
Depreciation expense
Supplies expense
Total
$59,500
$59,500
Adjusting data at July 31, 2012:
Unearned service revenue still unearned, $1,200.
Prepaid rent still in force at July 31, $1,900.
Supplies used during the month, $800.
Depreciation for the month, $300.
Accrued salary expense at July 31, $500.
Requirements
1. Journalize adjusting journal entries.
2. Enter the trial balance on a worksheet and complete the worksheet for Road Runner Internet.
3. Prepare the income statement, statement of retained earnings, and classified balance sheet in report form.
4. Using the worksheet data that you prepared, journalize the closing entries and post the adjusting and closing entries to T accounts. Use dates and show the ending balance of each account.
5. Prepare a post closing trial balance.
6. Calculate the current and debt ratios for the company.
Journalizing adjusting and closing entries The unadjusted trial balance and adjustment data of Smith Real Estate Appraisal Company at June 30, 2012, follow:
SMITH REAL ESTATE APPRAISAL COMPANY
Unadjusted Trial Balance
June 30, 2012
Account Title
Debit
Credit
Cash
$4,600
Accounts receivable
3,500
Supplies
3,000
Prepaid insurance
2,100
Building
74,700
Accumulated depreciation
$18,600
Land
14,000
Accounts payable
18,900
Interest payable
8,000
Salary payable
600
Common stock
7,000
Retained earnings
26,000
Dividends
27,000
Service revenue
97,500
Salary expense
32,100
Depreciation expense
0
Insurance expense
5,100
Utilities expense
3,600
Supplies expense
6,900
Total
$176,600
$176,600
Adjustment data at June 30, 2012:
Prepaid insurance expired, $400.
Accrued service revenue, $1,100.
Accrued salary expense, $700.
Depreciation for the year, $8,500.
Supplies used during the year, $100.
Requirements
1. Open T accounts for Retained earnings and all the accounts that follow on the trial balance. Insert their unadjusted balances. Also open a T account for Income summary, which has a zero balance.
2. Journalize the adjusting entries and post to the accounts that you opened. Show the balance of each revenue account and each expense account.
3. Journalize the closing entries and post to the accounts that you opened. Draw double underlines under each account balance that you close to zero.
4. Compute the ending balance of Retained earnings.
Preparing a classified balance sheet in report form, and using the current and debt ratios to evaluate a company Selected accounts of Browne Irrigation Systems at December 31, 2012, follow:
Insurance expense
$ 500
Accounts payable
$22,300
Note payable, long term
4,200
Accounts receivable
43,600
Other assets
2,000
Accumulated depreciation—building
24,200
Building
58,200
Common stock
16,300
Prepaid insurance
4,800
Accumulated depreciation—equipment
6,900
Salary expense
17,700
Cash
6,500
Salary payable
2,800
Interest payable
400
Service revenue
73,000
Retained earnings, December 31, 2011
32,700
Supplies
3,300
Equipment
23,000
Unearned service revenue
1,800
Depreciation expense
25,000
Requirements
1. Prepare the company’s classified balance sheet in report form at December 31, 2012.
2. Compute the company’s current ratio and debt ratio at December 31, 2012. At December 31, 2011, the current ratio was 1.83 and the debt ratio was 0.39. Did the company’s ability to pay debts improve or deteriorate, or did it remain the same during 2012?
One year ago, Ralph Collins founded Collins Consignment Sales Company, and the business has prospered. Collins comes to you for advice. He wishes to know how much net income the business earned during the past year. The accounting records consist of the T accounts in the ledger, which were prepared by an accountant who has moved. The accounts at December 31 follow:
Cash
Accounts receivable
Prepaid rent
Supplies
Dec 31 Bal
5,800
Dec 31 Bal 12300
41641
jan 2
2600
Equipment
Accumulated depreciation
Accounts payable
Jan 2
52,000
Unearned service revenue
Common stock
Dividends
18,500
Salary payable
Dec 31 Bal 12300
41641
Dec 31 Bal
50,000
Service revenue
Salary expense
Dec 31 Bal
Dec 31 Bal
17000
Depreciation expense
80700
Advertising expense
Utilities expense
Supplies expense
Dec 31 Bal
800
Collins indicates that, at year end, customers owe him $1,000 accrued service revenue, which he expects to collect early next year. These revenues have not been recorded. During the year, he collected $4,100 service revenue in advance from customers, but the business has earned only $800 of that amount. During the year he has incurred $2,400 of advertising expense, but he has not yet paid for it. In addition, he has used up $2,100 of the supplies. Collins determines that depreciation on equipment was $7,000 for the year. At December 31, he owes his employee $1,200 accrued salary. The company issued no stock during the year. Collins expresses concern that dividends during the year might have exceeded the business’s net income. To get a loan to expand the business, Collins must show the bank that the business’s stockholders’ equity has grown from its original $40,000 balance. Has it? You and Collins agree that you will meet again in one week.
Requirement
1. Prepare the financial statement that helps address the first issue concerning Collins. Can he expect to get the loan? Give your reason(s).
Grant Film Productions wishes to expand and has borrowed $100,000. As a condition for making this loan, the bank requires that the business maintain a current ratio of at least 1.50.
Business has been good but not great. Expansion costs have brought the current ratio down to 1.40 on December 15. Rita Grant, owner of the business, is considering what might happen if she reports a current ratio of 1.40 to the bank. One course of action for Grant is to record in December $10,000 of revenue that the business will earn in January of next year. The contract for this job has been signed.
Requirements
1. Journalize the revenue transaction, and indicate how recording this revenue in December would affect the current ratio.
2. Discuss whether it is ethical to record the revenue transaction in December. Identify the accounting principle relevant to this situation, and give the reasons underlying your conclusion.
Arthur Chen, a newly minted CPA, was on his second audit job in the Midwest with a new client called Parson Farm Products, Inc. He was looking through the last four years of financials, and doing a few ratios, when he noticed something odd. The current ratio went from 1.9 in 2007 down to 0.3 in 2008, despite the fact that 2008 had record income. He decided to sample a few transactions from December 2008. He found that many of Parson’s customers had returned products to the company because of substandard quality. Chen discovered that the company was clearing the receivables (i.e., crediting accounts receivable) but “stashing” the debits in an obscure long term asset account called “grain reserves” to keep the company’s income “in the black” (i.e., positive income).
Requirements
1. How did the fraudulent accounting just described affect the current ratio? (Hint: Think about Cash.)
2. Can you think of any reasons why someone in the company would want to take this kind of action?
Kathy Wintz formed a lawn service business as a summer job. To start the business on May 1, she deposited $1,000 in a new bank account in the name of the business. The $1,000 consisted of a $600 loan from Bank One to her company, Wintz Lawn Service, and $400 of her own money. The company issued $400 of common stock to Wintz. Wintz rented lawn equipment, purchased supplies, and hired other students to mow and trim customers’ lawns. At the end of each month, Wintz mailed bills to the customers. On August 31, she was ready to dissolve the business and return to college. Because she was so busy, she kept few records other than the checkbook and a list of receivables from customers.
At August 31, the business’s checkbook shows a balance of $2,000, and customers still owe $750. During the summer, the business collected $5,500 from customers. The business checkbook lists payments for supplies totaling $400, and it still has gasoline, weed eater cord, and other supplies that cost a total of $50. The business paid employees $1,800 and still owes them $300 for the final week of the summer. Wintz rented some equipment from Ludwig’s Machine Shop. On May 1, the business signed a six month rental agreement on mowers and paid $600 for the full rental period in advance. Ludwig’s will refund the unused portion of the prepayment if the equipment is returned in good shape. In order to get the refund, Wintz has kept the mowers in excellent condition. In fact, the business had to pay $300 to repair a mower. To transport employees and equipment to jobs, Wintz used a trailer that the business bought for $300. The business estimates that the summer’s work used up one third of the trailer’s service potential. The business checkbook lists a payment of $500 for cash dividends during the summer. The business paid the loan back during August. (For simplicity, ignore any interest expense associated with the loan.)
Requirements
1. Prepare the income statement and the statement of retained earnings of Wintz Lawn Service for the four months May through August.
2. Prepare the classified balance sheet of Wintz Lawn Service at August 31.
3. Was Wintz’s summer work successful? Give the reason for your answer.
Journalizing, Posting, Worksheet, Adjusting, Closing the Financial Statements
Matthews Delivery Service, Inc., completed the following transactions during its first month of operations for January 2012:
a. Matthews Delivery Service, Inc., began operations by receiving $6,000 cash and a truck valued at $11,000. The business issued common stock to aquire these assets.
b. Paid $300 cash for supplies.
c. Prepaid insurance, $700.
d. Performed delivery services for a customer and received $800 cash.
e. Completed a large delivery job, billed the customer $1,500, and received a promise to collect the $1,500 within one week.
f. Paid employee salary, $700.
g. Received $12,000 cash for performing delivery services.
h. Collected $600 in advance for delivery service to be performed later.
i. Collected $1,500 cash from a customer on account.
j. Purchased fuel for the truck, paying $200 with a company credit card. (Credit Accounts payable)
k. Performed delivery services on account, $900.
l. Paid office rent, $600. This rent is not paid in advance.
m. Paid $200 on account.
n. Paid cash dividends of $2,100.
Requirements
1. Record each transaction in the journal. Key each transaction by its letter. Explanations are not required.
2. Post the transactions that you recorded in Requirement 1 in the T accounts.
Cash
Service revenue
Accounts receivable
Salary expense
Supplies
Depreciation expense
Prepaid insurance
Insurance expense
Delivery truck
Fuel expense
Accumulated depreciation
Rent expense
Accounts payable
Supplies expense
Salary payable
Unearned service revenue
Common stock
Retained earnings
Dividends
Income summary
3. Enter the trial balance in the worksheet for the month ended January 31, 2012. Complete the worksheet using the adjustment data given at January 31.
a. Accrued salary expense, $700.
b. Depreciation expense, $60.
c. Prepaid insurance expired, $250.
d. Supplies on hand, $200.
e. Unearned service revenue earned during January, $500.
4. Prepare Matthews Delivery Service’s income statement and statement of retained earnings for the month ended January 31, 2012, and the classified balance sheet on that date. On the income statement, list expenses in decreasing order by amount—that is, the largest expense first, the smallest expense last.
5. Journalize and post the adjusting entries beginning with a.
6. Journalize and post the closing entries.
7. Prepare a post closing trial balance at January 31, 2012.
Suppose Heat Miser Air Conditioner Company engaged in the following transactions during June of the current year:
Jun 3
Purchased inventory on credit terms of 1/10 net eom (end of month), $1,600.
9
Returned 40% of the inventory purchased on June 3. It was defective.
12
Sold goods for cash, $920 (cost, $550).
15
Purchased goods for $5,000. Credit terms were 3/15, net 30.
16
Paid a $260 freight bill on goods purchased.
18
Sold inventory for $2,000 on credit terms of 2/10, n/30 (cost, $1,180).
22
Received returned goods from the customer of the June 18 sale, $800 (cost, $480).
24
Borrowed money from the bank to take advantage of the discount offered on the June 15 purchase. Signed a note payable to the bank for the net amount, $4,850.
24
Paid supplier for goods purchased on June 15.
28
Received cash in full settlement of the account from the customer who purchased inventory on June 18.
29
Paid the amount owed on account from the purchase of June 3.
Requirements
1. Journalize the preceding transactions. Explanations are not required.
2. Set up T accounts and post the journal entries to show the ending balances in the Inventory and the Cost of goods sold accounts only.
3. Assume that the note payable signed on June 24 requires the payment of $90 interest expense. Was borrowing funds to take the cash discount a wise or unwise decision? What was the net savings or cost of the decision?
The adjusted trial balance of King Cornelius Company follows:
KING CORNELIUS COMPANY Adjusted Trial Balance December 31, 2014
Cash
$ 5,600
Accounts receivable
37,100
Inventory
25,800
Supplies
1,300
Prepaid rent
1,000
Furniture
26,500
Accumulated depreciation
$ 23,800
Accounts payable
6,300
Salary payable
2,000
Interest payable
600
Unearned sales revenue
2,400
Note payable, long term
35,000
Common stock
5,000
Retained earnings
17,200
Dividends
48,000
Sales revenue
244,000
Interest revenue
2,000
Sales discounts
10,000
Sales returns and allowances
8,000
Cost of goods sold
81,000
Salary expense
72,700
Rent expense
7,700
Depreciation expense
2,700
Utilities expense
5,800
Supplies expense
2,200
Interest expense
2,900
Total
$338,300
$338,300
Requirements
1. Journalize the closing entries at December 31. Post to the Income summary account as an accuracy check on net income. Recall that the credit balance closed out of Income summary should equal net income as computed on the income statement. Also post to Retained earnings, whose balance should agree with the amount reported on the balance sheet.
2. Prepare the company’s multi step income statement, statement of retained earnings, and balance sheet in account form. Draw arrows linking the statements.
Note: King Cornelius doesn’t separate its operating expenses as either selling or general.
3. Compute the inventory turnover and days in inventory for 2014. Inventory at December 31, 2013, was $21,000. Turnover for 2013 was 3.0 times. Would you expect King Cornelius Company to be more profitable or less profitable in 2014 than in 2013? Why?
Suppose Dave’s Discount’s Inventory account showed a balance of $8,000 before the yearend adjustments. The physical count of goods on hand totaled $7,400. To adjust the accounts, Dave Marshall would make the following entry:
Describing periodic and perpetual inventory systems The following characteristics may be related to either periodic inventory or perpetual inventory systems or both.
a. Purchases of inventory are journalized to an asset account at the time of purchase.
b. Purchases of inventory are journalized to an expense account at the time of purchase.
c. Inventory records are constantly updated.
c. Sales made require a second entry to be journalized to record cost of goods sold.
d. Bar code scanners that record sales transactions are most often associated with this inventory system.
e. A physical count of goods on hand at year end is required.
Requirement
1. Identify each characteristic as one of the following:
Posting closing entries Patel Insurance Agency reported the following items at September 30:
Sales and marketing expense
$1,600
Cash
$1,300
Other assets
700
Service revenue
4,000
Depreciation expense
900
Retained earnings
500
Long term liabilities
600
Accounts receivable
900
Requirement
1. Prepare T accounts for Patel Insurance Agency. Insert the account balances prior to closing. Post the closing entries to the affected T accounts, and show each account’s ending balance after closing. Also show the Income summary T account. Denote a balance as Bal and a closing entry amount as Clo.
Preparing a worksheet Data for the unadjusted trial balance of Mexican Riviera Tanning Salon at March 31, 2012, follow.
Cash
$13,000
Service revenue
$89,900
Equipment
66,500
Salary expense
42,200
Accumulated depreciation
18,500
Depreciation expense
Accounts payable
3,200
Supplies expense
Supplies
1,400
Retained earnings
1,500
Common stock
10,000
Adjusting data for March 2012 are:
a. Accrued service revenue, $2,600.
b. Supplies used in operations, $400.
c. Accrued salary expense, $1,700.
d. Depreciation expense, $4,100.
Les Neeland, the principal stockholder, has received an offer to sell the company. He needs to know the net income for the month covered by these data.
Requirements
1. Prepare the worksheet for Mexican Riviera Tanning Salon.
2. How much was the net income/net loss for March?
Identifying and journalizing closing entries Gunther recorded the following transactions and year end adjustments during 2012:
Journal Entry
Accounts and Explanations
Debit
Credit
Prepaid rent
8,000
Cash
8,000
Prepaid the annual rent.
Rent expense
5,100
Prepaid rent
5,100
Adjustment to record rent expense for the year.
Cash
4,200
Unearned service revenue
4,200
Collected cash in advance of service revenue to be earned.
Unearned service revenue
4,700
Service revenue
4,700
Adjustment to record revenue earned.
Requirements
1. Assuming that there were no other service revenue and rent expense transactions during 2012, journalize Gunther’s closing entries at the end of 2012.
2. Open T accounts for Service revenue and Rent expense. Post the closing entries to these accounts. What are their balances after closing?
Identifying and journalizing closing entries The accountant for Klein Photography has posted adjusting entries (a)–(e) to the following selected accounts at December 31, 2012.
Accounts receivable
Supplies
46,000
5,000
(b) 2,400
(a) 2,000
Accumulated depr.—furniture
Accumulated depr.—building
8,000
30,000
(c) 800
(d) 6,200
Salary payable
Retained earnings
(e) 700
47,000
Dividends
Service revenue
57,000
108,000
(a) 2,000
Salary expense
Supplies expense
25,400
(b) 2,400
(e) 700
Depreciation expense—furniture
Depreciation expense—building
(c) 800
(d) 6,200
Requirements
1. Journalize Klein Photography’s closing entries at December 31, 2012.
2. Determine Klein Photography’s ending Retained earnings balance at December 31, 2012.
Preparing a classified balance sheet, and calculating the current and debt ratios The adjusted trial balance and the income statement amounts from the August worksheet of Brian O’Brion Dance Studio Company follow:
BRIAN O’BRION DANCE STUDIO COMPANY
Partial Worksheet
Month Ended August 31, 2012
Adjusted Trial Balance
Account
Debit
Credit
Cash
$15,800
Supplies
2,000
Prepaid rent
900
Equipment
49,000
Accumulated depreciation
$ 5,500
Accounts payable
4,500
Salary payable
500
Unearned service revenue
5,100
Long term note payable
4,400
Common stock
12,800
Retained earnings
23,700
Dividends
1,100
Service revenue
18,100
Salary expense
3,000
Rent expense
1,500
Depreciation expense
300
Supplies expense
400
Utilities expense
600
Total
$74,600
$74,600
Requirements
1. Prepare the classified balance sheet of Brian O’Brion Dance Studio Company at August 31, 2012. Use the report form. You must compute the ending balance of Retained earnings.
2. Compute O’Brion’s current ratio and debt ratio at August 31, 2012. One year ago, the current ratio was 1.49 and the debt ratio was 0.29. Indicate whether O’Brion’s ability to pay current and total debts has improved, deteriorated, or remained the same during the current year.
Preparing a worksheet and the financial statements The trial balance and adjustment data of Myla’s Motors, Inc., at November 30, 2012, follow:
MYLA’S MOTORS, INC.
Trial Balance
November 30, 2012
Balance
Account
Debit
Credit
Cash
$ 4,300
Accounts receivable
26,600
Supplies
500
Prepaid insurance
1,700
Equipment
53,500
Accumulated depreciation
$36,400
Accounts payable
13,400
Wages payable
Unearned service revenue
8,000
Common stock
6,000
Retained earnings
13,700
Dividends
3,800
Service revenue
16,000
Depreciation expense
Wage expense
1,600
Insurance expense
Utilities expense
1,500
Supplies expense
Total
$93,500
$93,500
Additional data at November 30, 2012:
Depreciation on equipment, $1,100.
Accrued wage expense, $600.
Supplies on hand, $200.
Prepaid insurance expired during November, $200.
Unearned service revenue earned during November, $4,000.
Accrued service revenue, $800.
Requirements
1. Complete Myla’s worksheet for November. Key adjusting entries by letter.
2. Prepare the income statement, the statement of retained earnings, and the classified balance sheet in account form for the month ended November 30, 2012.
Preparing a worksheet, financial statements, and closing entries The trial balance of Fugazy Investment Advisers, Inc., at December 31, 2012, follows:
FUGAZY INVESTMENT ADVISERS, INC.
Trial Balance
December 31, 2012
Balance
Account
Debit
Credit
Cash
$ 32,000
Accounts receivable
46,000
Supplies
3,000
Equipment
25,000
Accumulated depreciation
$ 11,000
Accounts payable
15,000
Salary payable
Unearned service revenue
2,000
Note payable, long term
39,000
Common stock
17,600
Retained earnings
20,400
Dividends
50,000
Service revenue
97,000
Salary expense
32,000
Supplies expense
Depreciation expense
Interest expense
3,000
Rent expense
9,000
Insurance expense
2,000
Total
$202,000
$202,000
Adjustment data at December 31, 2012:
Unearned service revenue earned during the year, $500.
Supplies on hand, $1,000.
Depreciation for the year, $6,000.
Accrued salary expense, $1,000.
Accrued service revenue, $4,000.
Requirements
1. Enter the account data in the Trial Balance columns of a worksheet, and complete the worksheet through the Adjusted Trial Balance. Key each adjusting entry by the letter corresponding to the data given. Leave a blank line under Service revenue.
2. Prepare the income statement, the statement of retained earnings, and the classified balance sheet in account format.
3. Prepare closing journal entries from the worksheet.
4. Did the company have a good or a bad year during 2012? Give the reason for your answer. (Challenge)
Completing the accounting cycle The trial balance of Wolfe Anvils, Inc., at October 31, 2012, and the data for the month end adjustments follow:
WOLFE ANVILS, INC.
Trial Balance
October 31, 2012
Balance
Account
Debit
Credit
Cash
$ 4,300
Accounts receivable
15,000
Prepaid rent
2,700
Supplies
1,600
Equipment
31,200
Accumulated depreciation
$ 3,000
Accounts payable
6,900
Salary payable
Unearned service revenue
5,400
Common stock
5,000
Retained earnings
21,600
Dividends
3,500
Service revenue
18,900
Salary expense
2,500
Rent expense
Depreciation expense
Supplies expense
Total
$60,800
$60,800
Adjustment data:
Unearned service revenue still unearned at October 31, $1,200.
Prepaid rent still in force at October 31, $2,500.
Supplies used during the month, $1,000.
Depreciation for the month, $300.
Accrued salary expense at October 31, $200.
Requirements
1. Prepare adjusting journal entries.
2. Enter the trial balance on a worksheet and complete the worksheet through the Adjusted Trial Balance of Wolfe Anvils for the month ended October 31, 2012.
3. Prepare the income statement, the statement of retained earnings, and the classified balance sheet in report form.
4. Using the worksheet data that you prepared, journalize the closing entries and post the adjusting and closing entries to T accounts. Use dates and show the ending balance of each account.
5. Prepare a post closing trial balance.
6. Calculate the current and debt ratios for the company.
Completing the accounting cycle The trial balance of Racer Internet, Inc., at March 31, 2012, follows:
RACER INTERNET, INC.
Trial Balance
March 31, 2012
Balance
Account
Debit
Credit
Cash
$ 4,300
Accounts receivable
15,100
Prepaid rent
2,300
Supplies
1,000
Equipment
30,600
Accumulated depreciation
$ 3,900
Accounts payable
6,400
Salary payable
Unearned service revenue
5,800
Common stock
4,000
Retained earnings
23,000
Dividends
4,100
Service revenue
17,300
Salary expense
3,000
Rent expense
Depreciation expense
Supplies expense
Total
$60,400
$60,400
Adjusting data at March 31, 2012:
Unearned service revenue still unearned, $500.
Prepaid rent still in force, $2,000.
Supplies used during the month, $800.
Depreciation for the month, $400.
Accrued salary expense, $600.
Requirements
1. Journalize adjusting journal entries.
2. Enter the trial balance on a worksheet and complete the worksheet of Racer Internet.
3. Prepare the income statement, statement of retained earnings, and classified balance sheet in report form.
4. Using the worksheet data that you prepared, journalize the closing entries, and post the adjusting and closing entries to T accounts. Use dates and show the ending balance of each account.
5. Prepare a post closing trial balance.
6. Calculate the current and debt ratios for the company.
Journalizing adjusting and closing entries The unadjusted trial balance and adjustment data of Elias Real Estate Appraisal Company at June 30, 2012, follow:
ELIAS REAL ESTATE APPRAISAL COMPANY
Unadjusted Trial Balance
June 30, 2012
Account Title
Debit
Credit
Cash
$4,900
Accounts receivable
4,000
Supplies
3,000
Prepaid insurance
2,200
Building
74,400
Accumulated depreciation
$18,800
Land
13,600
Accounts payable
19,500
Interest payable
8,800
Salary payable
1,300
Common stock
11,000
Retained earnings
19,800
Dividends
27,900
Service revenue
97,900
Salary expense
32,400
Depreciation expense
0
Insurance expense
4,200
Utilities expense
4,000
Supplies expense
6,500
Total
$177,100
$177,100
Adjustment data at June 30, 2012:
Prepaid insurance expired, $300.
Accrued service revenue, $1,300.
Accrued salary expense, $900.
Depreciation for the year, $8,500.
Supplies used during the year, $600.
Requirements
1. Open T accounts for Retained earnings and all the accounts that follow on the trial balance. Insert their unadjusted balances. Also open a T account for Income summary, which has a zero balance.
2. Journalize the adjusting entries and post to the accounts that you opened. Show the balance of each revenue account and each expense account.
3. Journalize the closing entries and post to the accounts that you opened. Draw double underlines under each account balance that you close to zero.
4. Compute the ending balance of Retained earnings
Preparing a classified balance sheet in report form, and using the current and debt ratios to evaluate a company Selected accounts of Blume Irrigation System at December 31, 2012, follow:
Insurance expense
$ 900
Accounts payable
$24,700
Note payable, long term
2,800
Accounts receivable
43,100
Other assets
2,200
Accumulated depreciation—building
24,000
Building
55,800
Common stock
16,900
Prepaid insurance
4,000
Accumulated depreciation—equipment
7,900
Salary expense
16,300
Cash
11,000
Salary payable
3,900
Interest payable
400
Service revenue
74,800
Retained earnings, December 31, 2011
33,100
Supplies
3,300
Equipment
23,000
Unearned service revenue
1,600
Depreciation expense
30,500
Requirements
1. Prepare the company’s classified balance sheet in report form at December 31, 2012.
2. Compute the company’s current ratio and debt ratio at December 31, 2012. At December 31, 2011, the current ratio was 1.81 and the debt ratio was 0.34. Did the company’s ability to pay debts improve or deteriorate, or did it remain the same during 2012?
Preparing a worksheet and the financial statements The trial balance and adjustment data of Brooke’s Motors, Inc., at September 30, 2012, follow:
BROOKE’S MOTORS, INC.
Trial Balance
September 30, 2012
Balance
Account
Debit
Credit
Cash
$ 4,200
Accounts receivable
26,500
Supplies
800
Prepaid insurance
1,800
Equipment
53,500
Accumulated depreciation
$36,300
Accounts payable
13,300
Wages payable
Unearned service revenue
8,500
Common stock
6,000
Retained earnings
13,000
Dividends
3,500
Service revenue
16,500
Depreciation expense
Wage expense
2,100
Insurance expense
Utilities expense
1,200
Supplies expense
Total
$93,600
$93,600
Additional data at September 30, 2012:
Depreciation on equipment, $1,100.
Accrued wage expense, $500.
Supplies on hand, $700.
Prepaid insurance expired during September, $200.
Unearned service revenue earned during September, $4,500.
Accrued service revenue, $900.
Requirements
1. Complete Brooke’s worksheet for September. Key adjusting entries by letter.
2. Prepare the income statement, the statement of retained earnings, and the classified balance sheet in account form for the month ended September 30, 2012.
Preparing a worksheet, financial statements, and closing entries The trial balance of Giambi Investment Advisers, Inc., at December 31, 2012, follows:
GIAMBI INVESTMENT ADVISERS, INC.
Trial Balance
December 31, 2012
Balance
Account
Debit
Credit
Cash
$ 28,000
Accounts receivable
50,000
Supplies
8,000
Equipment
26,000
Accumulated depreciation
$ 16,000
Accounts payable
14,000
Salary payable
Unearned service revenue
1,000
Note payable, long term
44,000
Common stock
19,600
Retained earnings
20,400
Dividends
50,000
Service revenue
97,000
Salary expense
32,000
Supplies expense
Depreciation expense
Interest expense
7,000
Rent expense
7,000
Insurance expense
4,000
Total
$212,000
$212,000
Adjustment data at December 31, 2012:
Unearned service revenue earned during the year, $500.
Supplies on hand, $5,000.
Depreciation for the year, $8,000.
Accrued salary expense, $1,000.
Accrued service revenue, $3,000.
Requirements
1. Enter the account data in the Trial Balance columns of a worksheet, and complete the worksheet through the Adjusted Trial Balance. Key each adjusting entry by the letter corresponding to the data given. Leave a blank line under Service revenue.
2. Prepare the income statement, the statement of retained earnings, and the classified balance sheet in account format.
3. Prepare closing journal entries from the worksheet.
4. Did the company have a good or a bad year during 2012? Give the reason for your answer. (Challenge)
Completing the accounting cycle The trial balance of Leopard Anvils, Inc., at January 31, 2012, and the data for the month end adjustments follow:
LEOPARD ANVILS, INC.
Trial Balance
January 31, 2012
Balance
Account
Debit
Credit
Cash
$ 4,400
Accounts receivable
14,800
Prepaid rent
2,300
Supplies
1,200
Equipment
30,100
Accumulated depreciation
$ 4,600
Accounts payable
7,500
Salary payable
Unearned service revenue
4,900
Common stock
5,000
Retained earnings
20,700
Dividends
4,800
Service revenue
17,400
Salary expense
2,500
Rent expense
Depreciation expense
Supplies expense
Total
$60,100
$60,100
Adjustment data:
Unearned service revenue still unearned at January 31, $400.
Prepaid rent still in force at January 31, $1,800.
Supplies used during the month, $1,100.
Depreciation for the month, $400.
Accrued salary expense at January 31, $500.
Requirements
1. Prepare adjusting journal entries.
2. Enter the trial balance on a worksheet and complete the worksheet through the Adjusted Trial Balance of Leopard Anvils for the month ended January 31, 2012.
3. Prepare the income statement, the statement of retained earnings, and the classified balance sheet in report form.
4. Using the worksheet data that you prepared, journalize and post the adjusting and closing entries to T accounts. Use dates and show the ending balance of each account.
5. Prepare a post closing trial balance.
6. Calculate the current and debt ratios for the company.
Preparing financial statements from an adjusted trial balance. The adjusted trial balance of Party Piano Tuning Service, Inc., at fiscal yearend May 31, 2012, follows.
PARTY PIANO TUNING SERVICE, INC.
Adjusted Trial Balance
May 31, 2012
Balance
Account Title
Debit
Credit
Cash
$ 12,600
Accounts receivable
10,800
Supplies
1,900
Equipment
25,900
Accumulated depreciation
$ 12,500
Accounts payable
3,300
Unearned service revenue
4,700
Salary payable
800
Note payable
14,000
Common stock
1,800
Retained earnings
11,800
Dividends
38,000
Service revenue
65,000
Depreciation expense
5,600
Salary expense
9,600
Utilities expense
3,900
Insurance expense
3,700
Supplies expense
1,900
Total
$113,900
$113,900
Requirements
1. Prepare Party’s 2012 income statement.
2. Prepare the statement of retained earnings for the year.
3. Prepare the year end balance sheet.
4. Which financial statement reports Party’s results of operations? Were the 2012 operations successful? Cite specifics from the financial statements to support your evaluation.
5. Which statement reports the company’s financial position?
Applying the revenue principle Nibble’s Cookies uses the accrual method of accounting and properly records transactions on the date they occur. Descriptions of customer transactions follows:
a. Received $4,800 cash from customer for six months of service beginning January 1, 2012.
b. Catered event for customer on January 28. Customer paid Nibble’s invoice of $800 on February 10.
c. Scheduled catering event to be held June 3. Customer paid Nibble’s a $750 deposit on February 25.
d. Catered customer’s wedding on February 3. Customer paid Nibble’s a $600 deposit on January 15 and the balance due of $1,500 on February 3.
e. The company provided catering to a local church’s annual celebration service on February 15. The church paid the $900 fee to Nibble’s on the same day.
f. The company provides food to the local homeless shelter two Saturdays each month. The cost of each event to the shelter is $260. The shelter paid Nibble’s $1,040 on February 25 for January and February’s events.
g. On December 1, 2011, Nibble’s entered into an annual service contract with an oil company to cater the customer’s monthly staff events. The contract total amount was $8,000, but Nibble’s offered a 1% discount since the customer paid the entire year in advance at the signing of the contract. The first event was held in December of last year.
h. Nibble’s signed contract for $1,600 on February 5 to cater X treme sports events to be held June 15, June 27, October 1, and November 15.
Requirement
1. Calculate the amount of revenue earned during February, 2012 for Nibble’s Cookies for each transaction.
Explain why an adjusting entry is needed and calculate the amount of the adjustment Descriptions of transactions and how they were recorded follows for October, 2012 for Ashley Acoustics, Inc.
a. Received $3,600 cash from customer for three months of service beginning October 1, 2012 and ending December 31, 2012. The company recorded a $3,600 debit to Cash and a $3,600 credit to Unearned service revenue.
b. Employees are paid $1,500 every Friday for the five day work week. October 31, 2012 is on Wednesday.
c. The company pays $420 on October 1 for their six month auto insurance policy. The company recorded a $420 debit to Prepaid insurance and a $420 credit to Cash.
d. The company purchased office furniture for $6,000 on January 2, 2012. The company recorded a $6,000 debit to Office furniture and a $6,000 credit to Accounts payable. Annual depreciation for the furniture is $1,200.
e. The company began October with $55 of supplies on hand. On October 10 the company purchased supplies on account of $115. The company recorded a $115 debit to Supplies and a $115 credit to Accounts payable. The company used $80 of supplies during October.
f. The company received their electric bill on October 30 for $205, but did not pay it until November 10. On November 10 they recorded a $205 debit to Utilities expense and a $205 credit to Cash.
g. The company paid November’s rent on October 30 of $550. On October 30 the company recorded a $550 debit to Rent expense and a $550 credit to Cash.
Requirement
1. Indicate if an adjusting entry is needed for each item on October 31 and why the entry is needed (i.e., an asset or liability account is over/understated). Indicate which specific account on the balance sheet is misstated. Finally, indicate the correct balance that should appear in the balance sheet account after the adjustment is made. Use the table guide below. Item a is completed as an example:
Comparing accrual and cash basis accounting, preparing adjusting entries, and preparing income statements Carolina’s Golf School, Inc., completed the following transactions during October, 2012:
Oct 1
Prepaid insurance for October through December, $900.
4
Performed services (gave golf lessons) on account, $2,400.
5
Purchased equipment on account, $1,500.
8
Paid property tax expense, $200.
11
Purchased office equipment for cash, $1,000.
19
Performed services and received cash, $700.
24
Collected $500 on account.
26
Paid account payable from October 5.
29
Paid salary expense, $1,400.
31
Recorded adjusting entry for October insurance expense (see October 1).
31
Debited unearned revenue and credited revenue in an adjusting entry, $1,100.
Requirements
1. Prepare journal entries for each transaction.
2. Using the journal entries as a guide, show whether each transaction would be handled as a revenue or an expense, using both the accrual and cash basis, by completing the following table:
Amount of Revenue (Expense) for October
Date
Cash Basis Amount of Revenue (Expense)
Accrual Basis Amount of Revenue (Expense)
Oct
1
3. After completing the table, calculate the amount of net income or net loss for the company under the accrual and cash basis for October.
4. Considering your results from Requirement 3, which method gives the best picture of the true earnings of Carolina’s Golf School? Why?
Journalizing adjusting entries Lindsey Landscaping has the following independent cases at the end of the year on December 31, 2014.4
a. Each Friday, Lindsey pays employees for the current week’s work. The amount of the weekly payroll is $6,500 for a five day workweek. This year December 31 falls on a Wednesday.
b. Details of Prepaid insurance are shown in the account:
Prepaid insurance
Jan 1
$5,500
Lindsey prepays a full year’s insurance each year on January 1. Record insurance expense for the year ended December 31.
c. The beginning balance of Supplies was $4,200. During the year, Lindsey purchased supplies for $5,100, and at December 31, the supplies on hand total $2,400.
d. Lindsey designed a landscape plan, and the client paid Lindsey $9,000 at the start of the project. Lindsey recorded this amount as Unearned service revenue. The job will take several months to complete, and Lindsey estimates that the company has earned 70% of the total revenue during the current year.
e. Depreciation for the current year includes Equipment, $3,600; and Trucks, $1,400. Make a compound entry.
Requirement
1. Journalize the adjusting entry needed on December 31, 2014, for each of the previous items affecting Lindsey Landscaping.
Journalizing and posting adjustments to the T accounts, and preparing an adjusted trial balance The trial balance of Canton Air Purification System, Inc., at December 31, 2012, and the data needed for the month end adjustments follow.
Preparing and posting adjusting journal entries; preparing an adjusted trial balance and financial statements. The trial balance of Concord Bed and Breakfast Corporation at December 31, 2012, and the data needed for the month end adjustments follow.
CONCORD BED AND BREAKFAST CORPORATION
Trial Balance
December 31, 2012
Account
Debit
Credit
Cash
$ 12,000
Accounts receivable
14,400
Prepaid insurance
2,800
Supplies
1,400
Building
435,000
Accumulated depreciation
$310,500
Accounts payable
1,930
Salary payable
Unearned service revenue
3,000
Common stock
122,000
Retained earnings
19,060
Dividends
2,940
Service revenue
15,700
Salary expense
2,800
Insurance expense
Depreciation expense
Advertising expense
850
Supplies expense
Total
$472,190
$472,190
Adjustment data at December 31 follow:
Prepaid insurance still in force, $900.
Supplies used during the month, $500.
Depreciation for the month, $1,000.
Accrued salary expense, $300.
Unearned service revenue still unearned, $1,500.
Requirements
1. Journalize the adjusting entries.
2. The unadjusted balances have been entered for you in the general ledger accounts. Post the adjusting entries to the ledger accounts.
3. Prepare the adjusted trial balance.
4. Prepare the income statement, statement of retained earnings, and balance sheet for the business for the month ended December 31, 2012.
Prepare an adjusted trial balance and financial statements Consider the unadjusted trial balance of Star Limo Service Company at September 30, 2012, and the related month end adjustment data.
STAR LIMO SERVICE COMPANY
Trial Balance
September 30, 2012
Balance
Account
Debit
Credit
Cash
$ 6,800
Accounts receivable
1,400
Prepaid rent
5,000
Supplies
1,200
Automobile
72,000
Accumulated depreciation
$ 3,800
Accounts payable
3,600
Salary payable
Common stock
61,200
Retained earnings
13,800
Dividends
3,700
Service revenue
9,700
Salary expense
1,400
Rent expense
Fuel expense
600
Depreciation expense
Supplies expense
Total
$92,100
$92,100
Adjustment data at September 30 follow:
Accrued service revenue at September 30, $1,800.
One fifth of the prepaid rent expired during the month.
Supplies on hand at September 30, $800.
Depreciation on automobile for the month, $1,000.
Accrued salary expense at September 30 for one day only.
The five day weekly payroll is $1,200.
Requirements
1. Write the trial balance on a worksheet, using Exhibit 3 8 as an example, and prepare the adjusted trial balance of Star Limo Service at September 30, 2012. Key each adjusting entry by letter.
2. Prepare the income statement and the statement of retained earnings for the month ended September 30, 2012, and the balance sheet at that date.
Preparing financial statements from an adjusted trial balance The adjusted trial balance of A Plus Events Piano Tuning Service, Inc., at fiscal yearend October 31, 2012, follows.
A PLUS EVENTS PIANO TUNING SERVICE, INC.
Adjusted Trial Balance
October 31, 2012
Balance
Account Title
Debit
Credit
Cash
$ 12,300
Accounts receivable
10,700
Supplies
1,800
Equipment
25,800
Accumulated depreciation
$ 12,300
Accounts payable
3,300
Unearned service revenue
4,600
Salary payable
700
Note payable
15,000
Common stock
1,700
Retained earnings
7,300
Dividends
36,000
Service revenue
66,000
Depreciation expense
5,500
Salary expense
9,600
Utilities expense
4,100
Insurance expense
3,700
Supplies expense
1,400
Total
$110,900
$110,900
Requirements
1. Prepare A Plus’s 2012 income statement.
2. Prepare the statement of retained earnings for the year.
3. Prepare the year end balance sheet.
4. Which financial statement reports A Plus’s results of operations? Were 2012 operations successful? Cite specifics from the financial statements to support your evaluation.
5. Which statement reports the company’s financial position?
Preparing adjusting entries; preparing an adjusted trial balance; and preparing financial statements from an adjusted trial balance This problem continues the Draper Consulting, Inc., Start from the trial balance and the posted T accounts that Draper Consulting, Inc., prepared at December 18, 2012, as follows:
DRAPER CONSULTING, INC.
Trial Balance
December 18, 2012
Balance
Account Title
Debit
Credit
Cash
$ 16,500
Accounts receivable
1,500
Supplies
900
Equipment
1,800
Accumulated depreciation—equipment
Furniture
4,200
Accumulated depreciation—furniture
Accounts payable
$ 5,100
Salary payable
Unearned service revenue
Common stock
18,000
Retained earnings
Dividends
Service revenue
2,600
Rent expense
550
Utilities expense
250
Salary expense
Depreciation expense—equipment
Depreciation expense—furniture
Supplies expense
Total
$25,700
$25,700
Later in December, the business completed these transactions, as follows:
Dec 21
Received $1,400 in advance for client service to be performed evenly over the next 30 days.
21
Hired a secretary to be paid $2,055 on the 20th day of each month. The secretary begins work immediately.
26
Paid $450 on account.
28
Collected $300 on account.
30
Paid cash dividends of $1,400.
Requirements
1. Open these additional T accounts: Accumulated depreciation—equipment; Accumulated depreciation—furniture; Salary payable; Unearned service revenue; Depreciation expense—equipment; Depreciation expense—furniture; Supplies expense.
2. Journalize the transactions of December 21–30.
3. Post to the T accounts, keying all items by date.
4. Prepare a trial balance at December 31. Also set up columns for the adjustments and for the adjusted trial balance,..
5. At December 31, the business gathers the following information for the adjusting entries:
Accrued service revenue, $550.
Earned $700 of the service revenue collected in advance on December 21.
On your worksheet, make these adjustments directly in the adjustments columns, and complete the adjusted trial balance at December 31. Throughout the book, to avoid rounding errors, we base adjusting entries on 30 day months and 360 day years.
6. Journalize and post the adjusting entries. In the T accounts, denote each adjusting amount as Adj and an account balance as Bal.
7. Prepare the income statement and the statement of retained earnings of Draper Consulting for the month ended December 31, 2012, and prepare the balance sheet at that date.
Lee Nicholas has been the principal stockholder and has operated World.com Advertising, Inc., since its beginning 10 years ago. The company has prospered. Recently, Nicholas mentioned that he would sell the business for the right price. Assume that you are interested in buying World.com Advertising. You obtain the most recent monthly trial balance, which follows. Revenues and expenses vary little from month to month, and January is a typical month. The trial balance shown is a preliminary or unadjusted trial balance. The controller informs you that the necessary accrual adjustments should include revenues of $3,800 and expenses of $1,100. Also, if you were to buy World.com Advertising, you would hire a manager so you could devote your time to other duties. Assume that this person would require a monthly salary of $5,000.
WORLD.COM ADVERTISING, INC. Trial Balance January 31, 2015
Balance
Accounts Title
Debit
Credit
Cash
$9,700
Accounts receivable
14,100
Prepaid expenses
2,600
Building
221,300
Accumulated depreciation
$68,600
Accounts payable
13,000
Salary Payable
Unearned service revenue
56,700
Common Stock
50,000
Retained earning
3,400
60,400
Dividends
9000
Service revenue
12,300
Rent expense
Salary expense
3400
Utilities expenses
900
Depreciation expenses
Supplies expenses
Total
$261,000
$261,000
Requirements
1. Assume that the most you would pay for the business is 20 times the monthly net income you could expect to earn from it. Compute this possible price.
2. Nicholas states the least he will take for the business is an amount equal to the business’s stockholders’ equity balance on January 31. Compute this amount.
3. Under these conditions, how much should you offer Nicholas? Give your reason.
The net income of Steinbach & Sons, a department store, decreased sharply during 2014. Mort Steinbach, manager of the store, anticipates the need for a bank loan in 2015. Late in 2014, Steinbach instructs the store’s accountant to record a $2,000 sale of furniture to the Steinbach family, even though the goods will not be shipped from the manufacturer until January 2015. Steinbach also tells the accountant not to make the following December 31, 2014, adjusting entries:
Salaries owed to employees
$900
Prepaid insurance that has expired
400
Requirements
1. Compute the overall effects of these transactions on the store’s reported income for 2014.
2. Why is Steinbach taking this action? Is his action ethical? Give your reason, identifying the parties helped and the parties harmed by Steinbach’s action. (Challenge)
3. As a personal friend, what advice would you give the accountant? (Challenge)
XM, Ltd., was a small engineering firm that built hi tech robotic devices for electronics manufacturers. One very complex device was partially completed at the end of 2014. Barb McLauren, head engineer and major shareholder, knew the experimental technology was a failure and XM would not be able to complete the $20,000,000 contract next year. However, she was getting ready to sell her shares and retire in January. She told the controller that the device was 80% complete at year end, and on track for successful completion the following spring; the controller accrued 80% of the contract revenue in December 2014. McLauren sold out in January 2015 and retired. By mid year, it became apparent that XM would not be able to complete the project successfully, and share prices dropped by 50%.
Requirements
1. For complex, hi tech contracts, how does a company determine the percentage of completion and the amount of revenue to accrue? (Challenge)
2. What action do you think was taken by XM in 2015 with regard to the revenue that had been accrued the previous year?
It’s Just Lunch is a nationwide service company that arranges lunch dates for clients. It’s Just Lunch collects cash up front for a package of dates. Suppose your group is opening an It’s Just Lunch office in your area. You must make some important decisions—where to locate, how to advertise, and so on—and you must also make some accounting decisions. For example, what will be the end of your business’s accounting year? How often will you need financial statements to evaluate operating performance and financial position? Will you use the cash basis or the accrual basis? When will you account for the revenue that the business earns? How will you account for the expenses?
Requirements
Write a report (or prepare an oral presentation, as directed by your professor) to address the following considerations:
1. Will you use the cash basis or the accrual basis of accounting? Give a complete explanation of your reasoning.
2. How often do you want financial statements? Why? Discuss how you will use each financial statement.
3. What kind of revenue will you earn? When will you record it as revenue?
4. Prepare a made up income statement for It’s Just Lunch for the year ended December 31, 2015.
List all the business’s expenses, starting with the most important (largest dollar amount) and working through to the least important (smallest dollar amount). Merely list the accounts. Dollar amounts are not required.
The trial balance of Super Employment Services, Inc., at December 31, 2014, follows.
SUPER EMPLOYMENT SERVICES, INC. Trial Balance December 31, 2014
Account Title
Debit
Credit
Cash
$6,000
Accounts receivable
5,000
Supplies
1,000
Furniture
10,000
Accumulated depreciation—furniture
$4,000
Building
50,000
Accumulated depreciation—building
30,000
Accounts payable
2,000
Salary payable
Unearned service revenue
8,000
Common stock
10,000
Retained earnings
2,000
Dividends
25,000
Service revenue
60,000
Salary expense
16,000
Supplies expense
Depreciation expense—furniture
Depreciation expense—building
Advertising expense
3,000
Total
$116,000
Data needed for the adjusting entries include the following:
a. Supplies on hand at year end, $200.
b. Depreciation on furniture, $2,000.
c. Depreciation on building, $1,000.
d. Salaries owed but not yet paid, $500.
e. Accrued service revenue, $1,300.
f. $3,000 of the unearned service revenue was earned during 2014.
Requirement
1. Prepare the worksheet of Super Employment Services for the year ended December 31, 2014. Key each adjusting entry by the letter corresponding to the data given.
Explaining worksheet items Consider the following list of accounts:
a.
Accounts receivable
f.
Accounts payable
b.
Supplies
g.
Unearned service revenue
c.
Prepaid rent
h.
Service revenue
d.
Furniture
i.
Rent expense
e.
Accumulated depreciation— furniture
Requirement
1. Explain what a normal balance in each account means. For example, if the account is “Cash,” the explanation would be “the balance of cash on a specific date.”
Posting closing entries directly to T accounts It is December 31 and time for your business to close the books. The following balances appear on the books of Sarah Simon Enterprises:
1. Set up each T account given and insert its adjusted balance as given (denote as Bal) at December 31. Also set up a T account for Retained earnings, $26,100, and for Income summary.
2. Post the closing entries to the accounts, denoting posted amounts as Clo.
3. Compute the ending balance of Retained earnings.
This case is an excerpt from a presentation given by former Chairman Arthur Levitt, Securities and Exchange Commission, the ‘‘Numbers Game,’’ to New York University Center for Law and Business, September 28, 1998.
Accounting Hocus Pocus
Our accounting principles weren’t meant to be a straitjacket. Accountants are wise enough to know they cannot anticipate every business structure or every new and innovative transaction, so they develop principles that allow for flexibility to adapt to changing circumstances. That’s why the highest standards of objectivity, integrity and judgment can’t be the exception. They must be the rule. Flexibility in accounting allows it to keep pace with business innovations. Abuses such as earnings management occur when people exploit this pliancy. Trickery is employed to obscure actual financial volatility. This, in turn, masks the true consequences of management’s decisions. These practices aren’t limited to smaller companies struggling to gain investor interest. It’s also happening in companies whose products we know and admire.
So what are these illusions? Five of the more popular ones I want to discuss today are ‘‘big bath’’ restructuring charges, creative acquisition accounting, ‘‘cookie jar reserves,’’ ‘‘immaterial’’ misapplications of accounting principles and the premature recognition of revenue. ‘‘Big Bath’’ Charges
Let me first deal with ‘‘Big Bath’’ restructuring charges.
Companies remain competitive by regularly assessing the efficiency and profitability of their operations. Problems arise, however, when we see large charges associated with companies restructuring. These charges help companies ‘‘clean up’’ their balance sheet—giving them a so called ‘‘big bath.’’
Why are companies tempted to overstate these charges? When earnings take a major hit, the theory goes Wall Street will look beyond a one time loss and focus only on future earnings.
And if these charges are conservatively estimated with a little extra cushioning, that so called conservative estimate is miraculously reborn as income when estimates change or future earnings fall short.
When a company decides to restructure, management and employees, investors and creditors, customers and suppliers all want to understand the expected effects. We need, of course, to ensure that financial reporting provides this information. But this should not lead to flushing all the associated costs—and maybe a little extra—through the financial statements.
Creative Acquisition Accounting
Let me turn now to the second gimmick.
In recent years, whole industries have been remade through consolidations, acquisitions and spinoffs. Some acquirers, particularly those using stock as an acquisition currency, have used this environment as an opportunity to engage in another form of ‘‘creative accounting.’’ I call it ‘‘merger magic.’’
I am not talking tonight about the pooling versus purchase problem. Some companies have no choice but to use purchase accounting—which can result in lower future earnings. But that’s a result some companies are unwilling to tolerate.
So what do they do? They classify an ever growing portion of the acquisition price as ‘‘in process’’
Research and Development, so—you guessed it—the amount can be written off in a ‘‘one time’’ charge—removing any future earnings drag. Equally troubling is the creation of large liabilities for future operating expenses to protect future earnings—all under the mask of an acquisition.
Miscellaneous ‘‘Cookie Jar Reserves’’
A third illusion played by some companies is using unrealistic assumptions to estimate liabilities for such items as sales returns, loan losses or warranty costs. In doing so, they stash accruals in cookie jars during the good times and reach into them when needed in the bad times.
I’m reminded of one U.S. company who took a large one time loss to earnings to reimburse franchisees for equipment. That equipment, however, which included literally the kitchen sink, had yet to be bought. And, at the same time, they announced that future earnings would grow an impressive 15 percent per year.
‘‘Materiality’’
Let me turn now to the fourth gimmick—the abuse of materiality—a word that captures the attention of both attorneys and accountants. Materiality is another way we build flexibility into financial reporting. Using the logic of diminishing returns, some items may be so insignificant that they are not worth measuring and reporting with exact precision.
But some companies misuse the concept of materiality. They intentionally record errors within a defined percentage ceiling. They then try to excuse that fib by arguing that the effect on the bottom line is too small to matter. If that’s the case, why do they work so hard to create these errors? Maybe because the effect can matter, especially if it picks up that last penny of the consensus estimate.
When either management or the outside auditors are questioned about these clear violations of GAAP, they answer sheepishly.…‘‘It doesn’t matter. It’s immaterial.’’
In markets where missing an earnings projection by a penny can result in a loss of millions of dollarsin market capitalization, I have a hard time accepting that some of these so called non events simply don’t matter.
Revenue Recognition
Lastly, companies try to boost earnings by manipulating the recognition of revenue. Think about a bottle of fine wine. You wouldn’t pop the cork on that bottle before it was ready. But some companies are doing this with their revenue—recognizing it before a sale is complete, before the product is delivered to a customer, or at a time when the customer still has options to terminate, void or delay the sale.
Required
a. ‘‘Big Bath’’—Comment on how a ‘‘Big Bath’’ would have enabled WorldCom to cover up its fraud.
b. Why would writing off ‘‘in process’’ Research and Development be similar to a ‘‘Big Bath’’?
c. How could a company use ‘‘allowance for doubtful accounts’’ as ‘‘Cookie Jar Reserves’’?
d. Speculate on how a company could use ‘‘Materiality’’ or disregard or partially disregard a specific accounting standard.
June 1996, New York Times columnist Bob Herbert wrote a pair of opinion editorials accusing Nike Corp. of cruelly exploiting cheap Asian labor. Nike CEO Philip Knight replied in a letter to the editor, which the Times published. Some of the information in the Knight letter included that Nike has, on average, paid double the minimum wage as defined in countries where its products are produced under contract.56
In 1998, Marc Kasky, a resident of California, sued Nike, alleging that the Knight letter violated California’s consumer protection laws against deceptive advertising and unfair business practices.57 In effect, the position was that the New York Times editorials were under the First Amendment, but that the Nike reply was under the Fifth Amendment. The First Amendment covers freedom of speech, while the Fifth Amendment covers commercial speech.
The California Supreme Court ruled in May 2002 that the Nike reply had to be viewed under the Fifth Amendment. The Supreme Court stated it was ‘‘commercial speech because it is both more readily verifiable by its speaker and more hardy than noncommercial speech, can be effectively regulatedto suppress false and actually or inherently misleading messages without undue risk of chilling public debate.’’58
Nike appealed the decision to the U.S. Supreme Court. The Supreme Court agreed to hear the case. In June 2003, the Supreme Court changed its mind and dismissed the matter on procedural grounds.59 Usually, the justices consider cases only after the state courts render a final decision; here, the state court had only said the speech was a commercial speech and sent the case back down for further proceedings—likely including a trial on whether the statements were indeed misleading. 60
A trial did not take place, as Nike settled on September 2003, agreeing to pay $1.5 million over a three year period to the Fair Labor Association, a Washington worker rights group.61
Required
a. Write a position paper on why the Nike reply should be viewed under the First Amendment.
b. Write a position paper on why the Nike reply should be viewed under the Fifth Amendment.
Selected data from Nike’s financial statements for the period 2005–2009 follow:
Item 6 Selected Financial Data (In Part)
Year Ended May 31,
2009
2008
2007
2006
2005
(In millions, except per share data and financial ratios)1
Revenues
$19,176.10
$18,627.00
$16,325.90
$14,954.90
$13,739.70
Gross margin
8,604.40
8,387.40
7,160.50
6,587.90
6,115.40
Gross margin %
44.90%
45.00%
43.90%
44.00%
44.50%
Restructuring charges
195
—
—
—
—
Goodwill impairment
199.3
—
—
—
—
Intangible and other asset impairment
202
—
—
—
—
Net income
1,486.70
1,883.40
1,491,5
1,392.00
1,211.60
Basic earnings per common share
3.07
3.8
2.96
2.69
2.31
Diluted earnings per common share
3.03
3.74
2.93
2.64
2.24
Weighted average common shares outstanding
484.9
495.6
503.8
518
525.2
Diluted weighted average common shares outstanding
490.7
504.1
509.9
527.6
540.6
Cash dividends declared per common share
0.98
0.875
0.71
0.59
0.475
Cash flow from operations
1,736.10
1,936.30
1,878.70
1,667.90
1,570.70
Price range of common stock
High
70.28
70.6
57.12
45.77
46.22
Low
38.24
51.5
37.76
38.27
34.31
At May 31,
Cash and equivalents
$2,291.10
$2,133.90
$1,856.70
$954.20
$1,388.10
Short term investments
1,164.00
642.2
990.3
1,348.80
436.6
Inventories
2,357.00
2,438.40
2,121.90
2,076.70
1,811.10
Working capital
6,457.00
5,517.80
5,492.50
4,733.60
4,339.70
Total assets
13,249.60
12,442.70
10,688.30
9,869.60
8,793.60
Long term debt
437.2
441.1
409.9
410.7
687.3
Redeemable Preferred Stock
0.3
0.3
0.3
0.3
0.3
Shareholders’ equity
8,693.10
7,825.30
7,025.40
6,285.20
5,644.20
Year end stock price
57.05
68.37
56.75
40.16
41.1
Market capitalization
27,697.80
33,576.50
28,472.30
20,564.50
21,462.30
Financial Ratios:
Return on equity
18.00%
25.40%
22.40%
23.30%
23.20%
Return on assets
11.60%
16.30%
14.50%
14.90%
14.50%
Inventory turns
4.4
4.5
4.4
4.3
4.4
Current ratio at May 31
3
2.7
3.1
2.8
3.2
Price/Earnings ratio at May 31
18.8
18.3
19.4
15.2
18.3
Note: There are many approaches to valuing a company. The analysts would likely review a company using several approaches.
Required
a. Liquidity
1. Review the summary analysis for Nike, Inc., from 2007–2009. Give your opinion of the liquidity position (refer back to Exhibit 3, Summary Analysis).
2. Review the current ratio in this case (2005–2009). Give your opinion of the liquidity position.
3. Review cash provided by operations (2005–2009). Give your opinion as to the trend.
b. Long term debt paying ability
1. Review the summary analysis for Nike, Inc., from 2007–2009. Give your opinion of the debt position (refer back to Exhibit 3, Summary Analysis).
2. Review the trend of long term debt in relation to total assets (2007–2009). Give your opinion of the debt trend.
c. Profitability
1. Review the summary analysis for Nike, Inc. from 2007–2009. Give your opinion of the profitability (refer back to Exhibit 3, Summary Analysis).
2. Review the trend in revenues (2005–2009). Comment on the trend.
3. Review the trend in gross margin (2005–2009). Comment on the trend.
d. Investor Analysis
1. Review the absolute amount and trend in the price/earnings. Considering liquidity, debt, and profitability, is there a reasonable probability that the price/earnings may increase?
2. Comment on the trend in market capitalization (2005–2009) (share price _ number of outstanding shares).
3. Review cash dividends declared per common share (2005–2009). Is there a likely chance that dividends will be increased during the year ended May 31, 2010?
4. Give your opinion of the stock price of Nike, Inc., on May 31, 2011. In practice, many things would be considered that are not presented in this case. Base your opinion on the summary analysis (2007–2009) and the data provided with this case.
e. Other
1. This case has used a fundamental financial statement approach to valuing Nike. In your opinion, would an analyst likely use this type of approach for valuing Nike? Comment.
1. For regulated utilities, are current liabilities usually presented first in utility reporting? Comment.
2. For regulated utilities, why review the account Construction Work in Progress?
3. For regulated utilities, describe the income statement accounts, allowance for equity funds used during construction, and allowance for borrowed funds used during construction.
3. Differentiate between successful efforts and fullcosting accounting as applied to the oil and gas industry.
4. Some industries described in this chapter are controlled by federal regulatory agencies. How does this affect their accounting systems?
5. When reviewing the financial statements of oil and gas companies, why is it important to note the method of costing (expensing) exploration and production costs?
Comparing accrual and cash basis accounting, and applying the revenue recognition principle Momentous Occasions is a photography business that shoots videos at college parties. The freshman class pays $100 in advance on March 3 just to guarantee your services for its party to be held April 2. The sophomore class promises a minimum of $280 for filming its formal dance, and actually pays cash of $410 on February 28 at the party.
Requirement
1. Answer the following questions about the correct way to account for revenue under the accrual basis.
a. Considering the $100 paid by the freshman class, on what date was revenue earned? Did the earnings occur on the same date cash was received?
b. Considering the $410 paid by the sophomore class, on what date was revenue earned? Did the earnings occur on the same date cash was received?
Comparing accrual and cash basis accounting, preparing adjusting entries, and preparing income statements Sweet Catering, Inc., completed the following selected transactions during May, 2012:
May 1
Prepaid rent for three months, $1,500.
5
Paid electricity expenses, $400.
9
Received cash for meals served to customers, $2,600.
14
Paid cash for kitchen equipment, $2,400.
23
Served a banquet on account, $3,000.
31
Made the adjusting entry for rent (from May 1).
31
Accrued salary expense, $1,400.
31
Recorded depreciation for May on kitchen equipment, $40.
Requirements
1. Prepare journal entries for each transaction.
2. Using the journal entries as a guide, show whether each transaction would be handled as a revenue or an expense using both the accrual and cash basis by completing the following table.
Amount of Revenue (Expense) for May
Date
Cash Basis Amount of
Accrual Basis Amount of
Revenue (Expense)
Revenue (Expense)
3. After completing the table, calculate the amount of net income or net loss for Sweet Catering under the accrual and cash basis for May.
4. Considering your results from Requirement 3, which method gives the best picture of the true earnings of Sweet Catering? Why?
Categorizing and journalizing adjusting entries Consider the following independent situations at December 31, 2014.
a. On August 1, a business collected $3,300 rent in advance, debiting Cash and crediting Unearned rent revenue. The tenant was paying one year’s rent in advance. At December 31, the business must account for the amount of rent it has earned.
b. Salary expense is $1,700 per day—Monday through Friday—and the business pays employees each Friday. This year December 31 falls on a Thursday.
c. The unadjusted balance of the Supplies account is $3,500. Supplies on hand total $1,700.
d. Equipment depreciation was $300.
e. On March 1, when the business prepaid $600 for a two year insurance policy, the business debited Prepaid insurance and credited Cash.
Requirements
1. For each situation, indicate which category of adjustment is described.
2. Journalize the adjusting entry needed on December 31 for each situation. Use the letters to label the journal entries.
Recording adjustments in T accounts and calculating ending balances The accounting records of Maura Grayson Architect, P.C., include the following selected, unadjusted balances at March 31: Accounts receivable, $1,400; Supplies, $1,100; Salary payable, $0; Unearned service revenue, $600; Service revenue, $4,200; Salary expense, $1,300; Supplies expense, $0. The data developed for the
March 31 adjusting entries are as follows:
a. Service revenue accrued, $900.
b. Unearned service revenue that has been earned, $200.
c. Supplies on hand, $600.
d. Salary owed to employee, $400.
Requirement
1. Open a T account for each account and record the adjustments directly in the T accounts, keying each adjustment by letter. Show each account’s adjusted balance. Journal entries are not required.
Preparing adjusting entries and preparing an adjusted trial balance First Class Maids Company, the cleaning service, started the preparation of its adjusted trial balance as follows:
FIRST CLASS MAIDS COMPANY
Preparation of Adjusted Trial Balance
December 31, 2012
Trial Balance
Account
Debit
Credit
Cash
$ 700
Supplies
3,000
Prepaid insurance
800
Equipment
29,000
Accumulated depreciation
$ 7,000
Accounts payable
2,800
Salary payable
Unearned service revenue
500
Common stock
5,100
Retained earnings
2,100
Dividends
3,000
Service revenue
25,000
Salary expense
6,000
Supplies expense
Depreciation expense
Insurance expense
Total
$42,500
$42,500
During the 12 months ended December 31, 2012, First Class Maids
a. used supplies of $1,800.
b. used up prepaid insurance of $620.
c. used up $460 of the equipment through depreciation.
d. accrued salary expense of $310 that First Class Maids hasn’t paid yet.
e. earned $360 of the unearned service revenue.
Requirement
1. Prepare an adjusted trial balance. Use Exhibit 3 8 as a guide. Key each adjustment by letter.
Using adjusting journal entries and computing financial statement amounts The adjusted trial balances of Superior International, Inc., at August 31, 2012, andAugust 31, 2011, include the following amounts:
2012
2011
Supplies
$2,400
$1,200
Salary payable
2,500
4,100
Unearned service revenue
12,100
17,100
Analysis of the accounts at August 31, 2012, reveals the following transactions for the fiscal year ending in 2012:
Cash payments for supplies
$ 6,100
Cash payments for salaries
47,300
Cash receipts in advance for service revenue
83,200
Requirement
1. Compute the amount of Supplies expense, Salary expense, and Service revenue to report on the Superior International income statement for 2012.
Preparing the income statement The accountant for Reva Stewart, CPA, P.C., has posted adjusting entries (a) through (e) to the accounts at December 31, 2012. Selected balance sheet accounts and all the revenues and expenses of the entity follow in T account form.
Accounts receivable
Supplies
22,700
1200(a)
600
(e)800
Acc.depr equipment
Acc.depr building
5000
30,000
(b)1,900
(c)5,000
Salary payables
Service revenue
(d)900
105,700
(e)800
Salary expense
Supplies expense
28,200
(a)600
(d)900
Depreciation expense equip
Depreciation expense bldg.
(b)1,900
(c)5,000
Requirements
1. Prepare the income statement of Reva Stewart, CPA, P.C., for the year ended December 31, 2012.
Applying the revenue principle Crum’s Cookies uses the accrual method of accounting and properly records transactions on the date they occur. Descriptions of customer transactions follow:
a. Received $3,000 cash from customer for six months of service beginning April 1, 2012.
b. Catered event for customer on April 28. Customer paid Crum’s invoice of $600 on May 10.
c. Scheduled catering event to be held June 3. Customer paid Crum’s a $500 deposit on May 25.
d. Catered customer’s wedding on May 3. Customer paid Crum’s an $800 deposit on April 15 and the balance due of $1,000 on May 3.
e. The company provided catering to a local church’s annual celebration service on May 15. The church paid the $800 fee to Crum’s on the same day.
f. The company provides food to the local homeless shelter two Saturdays each month. The cost of each event to the shelter is $280. The shelter paid Crum $1,120 on May 25 for April and May’s events.
g. On April 1, Crum’s entered into an annual service contract with an oil company to cater the customer’s monthly staff events. The contract’s total amount was $4,000, but Crum’s offered a 2.5% discount since the customer paid the entire year in advance at the signing of the contract. The first event was held in April.
h. Crum’s signed contract for $1,000 on May 5 to cater X treme sports events to be held June 15, June 27, October 1, and November 15.
Requirement
1. Calculate the amount of revenue earned during May, 2012 for Crum’s Cookies for each transaction.
Comparing accrual and cash basis accounting, preparing adjusting entries, and preparing income statements Charlotte’s Golf School, Inc., completed the following transactions during March, 2012:
Mar 1
Prepaid insurance for March through May, $600.
4
Performed services (gave golf lessons) on account, $2,500.
5
Purchased equipment on account, $1,600.
8
Paid property tax expense, $100.
11
Purchased office equipment for cash, $1,500.
19
Performed services and received cash, $900.
24
Collected $400 on account.
26
Paid account payable from March 5.
29
Paid salary expense, $1,000.
31
Recorded adjusting entry for March insurance expense (see March 1).
31
Debited unearned revenue and credited revenue in an adjusting entry, $1,200.
Requirements
1. Prepare journal entries for each transaction.
2. Using the journal entries as a guide, show whether each transaction would be handled as a revenue or an expense, using both the accrual and cash basis, by completing the following table.
Amount of Revenue (Expense) for March
Cash Basis Amount
Accrual Basis Amount
Date
of Revenue (Expense)
of Revenue (Expense)
Mar
1
3. After completing the table, calculate the amount of net income or net loss for the company under the accrual and cash basis for March.
4. Considering your results from Requirement 3, which method gives the best picture of the true earnings of Charlotte’s Golf School, Inc.? Why?
Journalizing adjusting entries Laughter Landscaping has the following independent cases at the end of the year on December 31, 2014. Each Friday, Laughter pays employees for the current week’s work. The amount of the weekly payroll is $7,000 for a five day workweek. This year December 31 falls on a Wednesday. Details of Prepaid insurance are shown in the account:
a. Each Friday, Laughter pays employees for the current week’s work. The amount of the weekly payroll is $7,000 for a five day workweek. This year December 31 falls on a Wednesday.
b. Details of Prepaid insurance are shown in the account:
Prepaid insurance
Jan 1 $4,500
Laughter prepays a full year’s insurance each year on January 1. Record insurance expense for the year ended December 31.
c. The beginning balance of Supplies was $4,000. During the year, Laughter purchased supplies for $5,200, and at December 31 the supplies on hand total $2,400.
d. Laughter designed a landscape plan, and the client paid Laughter $7,000 at the start of the project. Laughter recorded this amount as Unearned service revenue. The job will take several months to complete, and Laughter estimates that the company has earned 60% of the total revenue during the current year.
e. Depreciation for the current year includes Equipment, $3,700; and Trucks, $1,300. Make a compound entry.
Requirement
1. Journalize the adjusting entry needed on December 31, 2014, for each of the previous items affecting Laughter Landscaping.
Journalizing and posting adjustments to the T accounts and preparing an adjusted trial balance The trial balance of Arlington Air Purification System, Inc., at December 31, 2012, and the data needed for the month end adjustments follow.
ARLINGTON AIR PURIFICATION SYSTEM, INC.
Trial Balance
December 31, 2012
Account
Debit
Credit
Cash
$7,700
Accounts receivable
19,200
Prepaid rent
2,400
Supplies
1,300
Equipment
19,900
Accumulated depreciation
$4,300
Accounts payable
3,600
Salary payable
Unearned service revenue
2,600
Common stock
17,000
Retained earnings
22,500
Dividends
9,500
Service revenue
15,400
Salary expense
3,500
Rent expense
Depreciation expense
Advertising expense
1,900
Supplies expense
Total
$ 65,400
$ 65,400
Adjustment data at December 31 follow:
a. Unearned service revenue still unearned, $1,100.
b. Prepaid rent still in force, $500.
c. Supplies used during the month, $600.
d. Depreciation for the month, $900.
e. Accrued advertising expense, $900. (Credit Accounts payable)
f. Accrued salary expense, $1,100.
Requirements
1. Journalize the adjusting entries.
2. The unadjusted balances have been entered for you in the general ledger accounts. Post the adjusting entries to the ledger accounts.
3. Prepare the adjusted trial balance.
4. How will Arlington Air Purification System use the adjusted trial balance?
Preparing and posting adjusting journal entries; preparing an adjusted trial balance and financial statements The trial balance of Lexington Inn Corporation at December 31, 2012, and the data needed for the month end adjustments follow.
LEXINGTON INN CORPORATION
Trial Balance
December 31, 2012
Account
Debit
Credit
Cash
$ 12,100
Accounts receivable
14,300
Prepaid insurance
2,300
Supplies
1,100
Building
411,000
Accumulated depreciation
$312,500
Accounts payable
1,950
Salary payable
Unearned service revenue
2,400
Common stock
108,000
Retained earnings
6,740
Dividends
2,860
Service revenue
15,600
Salary expense
2,700
Insurance expense
Depreciation expense
Advertising expense
830
Supplies expense
Total
$447,190
$447,190
Adjustment data at December 31 follow:
a. Prepaid insurance still in force, $700.
b. Supplies used during the month, $500.
c. Depreciation for the month, $1,600.
d. Accrued salary expense, $400.
e. Unearned service revenue still unearned, $1,400.
Requirements
1. Journalize the adjusting entries.
2. The unadjusted balances have been entered for you in the general ledger accounts. Post the adjusting entries to the ledger accounts.
3. Prepare the adjusted trial balance.
4. Prepare the income statement, statement of retained earnings, and balance sheet for the business for the month ended December 31, 2012.
Prepare an adjusted trial balance and financial statements. Consider the unadjusted trial balance of Reliable Limo Service Company at June 30, 2012, and the related month end adjustment data.
RELIABLE LIMO SERVICE COMPANY
Trial Balance
June 30, 2012
Balance
Account
Debit
Credit
Cash
$ 6,900
Accounts receivable
1,100
Prepaid rent
3,500
Supplies
1,100
Automobile
77,000
Accumulated depreciation
$ 3,400
Accounts payable
3,300
Salary payable
Common stock
66,350
Retained earnings
13,650
Dividends
4,400
Service revenue
9,600
Salary expense
1,500
Rent expense
Fuel expense
800
Depreciation expense
Supplies expense
Total
$96,300
$96,300
Adjustment data at June 30 follow:
a. Accrued service revenue at June 30, $1,500.
b. One fifth of the prepaid rent expired during the month.
c. Supplies on hand at June 30, $700.
d. Depreciation on automobile for the month, $1,400.
e. Accrued salary expense at June 30 for one day only. The five day weekly payroll is $1,500.
Requirements
1. Write the trial balance on a worksheet, using Exhibit 3 8 as an example, and prepare the adjusted trial balance of Reliable Limo Service Company at June 30, 2012. Key each adjusting entry by letter.
2. Prepare the income statement and the statement of retained earnings for the month ended June 30, 2012, and the balance sheet at that date.
This case represents an actual retail company. The dates and format have been changed.
Required
a. Compute and comment on the following for 2005, 2006, and 2009:
1. Working capital
2. Current ratio
b. Comment on the difference between net income and net cash outflow from operating activities for the year ended December 31, 2006, and December 31, 2009.
c. This company reported a loss of $177,340,000 for 2010. Reviewing the balance sheet data, speculate on major reasons for this loss.
d. Considering (a), (b), and (c), comment on the wisdom of the short term bank loan in 2010. (Consider the company’s perspective and the bank’s perspective.)
1.
Selected Balance Sheet Data
31 Dec 06
31 Dec 05
Total current assets
$719,478,441
$628,408,895
Total current liabilities
458,999,682
366,718,656
THE RETAIL MOVER STATEMENT OF CASH FLOWS Year Ended December 31, 2006
Net cash flow from operating activities:
Net income
$39,577,000
Noncash expenses, revenues, losses, and gains included in income:
Increase in equity in Zeller’s Limited
2,777,000
Depreciation and amortization
9,619,000
Net increase in reserves
74,000
Increase in deferred federal income taxes
232,000
Net increase in receivables
51,463,995
Net increase in inventories
38,364,709
Net increase in prepaid taxes, rents, etc.
209,043
Increase in accounts payable
9,828,348
Increase in salaries, wages, and bonuses
470,054
Increase in taxes withheld from employees’ compensation
301,035
Decrease in taxes other than federal income taxes
659,021
Increase in federal income taxes payable
4,007,022
Increases in deferred credits, principally income taxes related to installment sales (short term)
14,045,572
Rounding difference in working capital
520
Net cash outflow from operating activities
15,319,217
Cash flows from investing activities:
Investment in properties, fixtures, and improvements
16,141,000
Investment in Zeller’s Limited
436,000
Increase in sundry accounts (net)
48,000
Net cash outflow from investing activities
16,625,000
Cash flows from financing activities:
Sales of common stock to employees
5,219,000
Dividends to stockholders
20,821,000
Purchase of treasury stock
13,224,000
Purchase of preferred stock for cancellation
948,000
Retirement of 4 3/4% sinking fund debentures
1,538,000
Increase in short term notes payable
56,323,016
Increase in bank loans
7,965,000
Net cash inflow from financing activities
32,976,016
Net increase in cash and short term securities
$1,031,799
2.
Selected Balance Sheet Data
31 Dec 09
Total current assets
$1,044,689,000
Total current liabilities
661,058,000
THE RETAIL MOVER STATEMENT OF CASH FLOWS Year Ended December 31, 2009
Net cash flow from operating activities:
Net income
$10,902,000
Noncash expenses, revenues, losses, and gains included in income:
Undistributed equity in net earnings of unconsolidated subsidiaries
3,570,000
Depreciation and amortization of properties
13,579,000
Increase in deferred federal income taxes—noncurrent
2,723,000
Decrease in deferred contingent compensation and other liabilities
498,000
Net receivables increase
52,737,000
Merchandise inventories increase
51,104,000
Other current assets increase
8,935,000
Accounts payable for merchandise decrease
2,781,000
Salaries, wages, and bonuses decrease
3,349,000
Other accrued expenses increase
3,932,000
Taxes withheld from employees increase
2,217,000
Sales and other taxes increase
448,000
Federal income taxes payable decrease
8,480,000
Increase in deferred income taxes related to installment sales
4,449,000
Net cash flow from operating activities
93,204,000
Cash flows from investing activities:
Investments on properties, fixtures, and improvements
23,143,000
Increase in other assets—net
642,000
Investment in Granjewel Jewelers & Distributors, Inc.
5,700,000
Net cash outflow from investing activities
29,485,000
Cash flows from financing activities:
Increase in short term notes payable to banks
100,000,000
Receipts from employees under stock purchase contracts
2,584,000
Short term commercial notes
73,063,000
Cash dividends to stockholders
21,122,000
Decrease in long term debt
6,074,000
Purchase of cumulative preferred stock, for cancellation
618,000
Purchase of treasury common stock
136,000
Bank loans decreased
10,000,000
Net cash inflow from financing activities
137,697,000
Net increase in cash
$15,008,000
3.
Income Statement Data related to 2009 and 2010 (in Part)
2010
2009
Net earnings (loss)
($177,340,000)
$10,902,000
Balance Sheet Data related to 2009 and 2010 (in Part)
December 31, 2010
December 31, 2009
Assets
Current assets:
Cash notes
$79,642,000
$45,951,000
Customers’ installment accounts receivable
518,387,000
602,305,000
Less:
Allowance for doubtful accounts
79,510,000
16,315,000
Unearned credit insurance premiums
1,386,000
4,923,000
Deferred finance income
37,523,000
59,748,000
399,968,000
521,319,000
Merchandise inventories
407,357,000
450,637,000
Other accounts receivable, refundable taxes, and claims
31,223,000
19,483,000
Prepaid expenses
6,591,000
7,299,000
Total current assets
$924,781,000
$1,044,689,000
Liabilities
Current liabilities:
Bank loans
$600,000,000
$ —
Short term commercial notes
—
453,097,000
Current portion of long term debt
995,000
—
Accounts payable for merchandise
50,067,000
58,192,000
Salaries, wages, and bonuses
10,808,000
14,678,000
Other accrued expenses
49,095,000
14,172,000
Taxes withheld from employees
1,919,000
4,412,000
Sales and other taxes
17,322,000
13,429,000
Federal income taxes payable
17,700,000
—
Deferred income taxes related to installment sales
2,000,000
103,078,000
Total current liabilities
749,906,000
661,058,000
Other liabilities
Long term debt
216,341,000
220,336,000
Deferred federal income taxes
—
14,649,000
Deferred contingent compensation and other liabilities
Owens Corning Takes $800 Million Non Cash Charge to Accrue for Future Asbestos Claims
‘‘This action demonstrates our desire to put the asbestos situation behind us,’’ new chairman and CEO Glen H. Hiner says.
Toledo, Ohio, February 6, 1992—Owens Corning Fiberglass Corp. (NYSE:OCF) today announced that its results for the fourth quarter and year ended December 31, 1991, include a special non cash charge of $800 million to accrue for the estimated uninsured cost of future asbestos claims the Company may receive through the balance of the decade. ‘‘This action demonstrates our desire to put the asbestos situation behind us,’’ said Glen Hiner, Owens Corning’s new chairman and chief executive officer. ‘‘After a thorough review of the situation with outside consultants, we believe this accrual will be sufficient to cover the company’s uninsured costs for cases received until the year 2000. We will, of course, make adjustments to our reserves if that becomes appropriate, but this is our best estimate of these uninsured costs. With this action,’’ Mr. Hiner continued, ‘‘everyone can now focus once again on the fundamental strengths of the Company. We generate considerable amounts of cash, our operating divisions are leaders in every market they serve throughout the world, and we have taken a number of steps in the last few years to strengthen our competitive position even further.’’
Owens Corning Fiberglass Corporation
For Immediate Release (June 20, 1996)
OWENS CORNING CONSOLIDATED STATEMENT OF CASH FLOWS (IN PART) For the years ended December 31, 1997, 1996 and 1995
(In millions of dollars)
1997
1996
1995
Net Cash Flow from Operations
Net income (loss)
$47
($284)
$231
Reconciliation of net cash provided by
operating activities:
Noncash items:
Provision for asbestos litigation claims (Note 22)
—
875
—
Cumulative effect of accounting change (Note 6)
15
—
Provision for depreciation and amortization
173
141
132
Provision (credit) for deferred income taxes (Note 11)
110
258
142
Other (Note 4)
49
2
2
(Increase) decrease in receivables (Note 13)
57
20
36
(Increase) decrease in inventories
60
71
15
Increase (decrease) in accounts payable and accrued Liabilities
60
103
50
Disbursements (funding) of VEBA trust
19
45
64
Proceeds from insurance for asbestos litigation claims, excluding Fibreboard (Note 22)
97
101
251
Payments for asbestos litigation claims, excluding Fibreboard (Note 22)
300
267
308
Other
136
68
68
Net cash flow from operations
131
335
285
April 29, 1998
Owens Corning opened a new front in its battle to avoid being swamped by tens of thousands of damage claims filed by people who say they got sick from exposure to asbestos containing insulation produced by the company. Owens Corning charged in U.S. District Court in Toledo, Ohio, that Allstate Insurance Co. is guilty of breach of contract by failing to provide coverage.
Owens Corning announced in March 1998 that it might have to spend more than expected to resolve asbestos claims because of growing damage awards to people with a severe form of asbestoslinked cancer called mesothelioma.
Required
a. In the long run, cash receipts from operations is equal to revenue from operations. Comment.
b. February 6, 1992—Owens Corning announced a special noncash charge of $800 million to accrue for the estimated uninsured cost of future asbestos claims the company may receive through the balance of the decade. How much will the noncash charge reduce gross earnings in 1992? Over what period of time is the expected outflow?
c. June 20, 1996—Owens Corning announced a net, after tax charge of $545 million for asbestos claims received after 1999. How much will this charge reduce net income in 1996? Over what period of time is the cash outflow expected?
d. Assume Owens Corning receives money related to the federal lawsuit alleging falsified medical tests. In what period will the cash inflow be recorded? When will the related revenue be recorded?
e. April 29, 1998—Owens Corning filed suit against Allstate Insurance Co. related to asbestos exposure coverage. What are the apparent implications if Owens Corning does not win the suit?
f. Owens Corning announced in March 1998 that it might have to spend more than expected to resolve asbestos claims. What does this imply as to future expenses and cash outflow related to asbestos claims?
g. Owens Corning, consolidated statement of cash flows, for the years ended December 31, 1997, 1996, and 1995.
1. What year has a charge for asbestos litigation claims?
2. What years have cash inflow from proceeds from insurance for asbestos litigation claims?
3. What years have payments for asbestos litigation claims?
Owens Corning went into Chapter 11 bankruptcy in 2000. In October 2002, it claimed that it was insolvent for four years before filing for bankruptcy (1996–2000). Apparently, the major issue was asbestos cases.
Because of the insolvent condition, it claims dividends paid were invalid during the period 1996–
2000. Owens Corning is only pursuing holders who received more than $100,000. This amounts to millions of dollars.
Required
Comment on implications to investors if firms in bankruptcy can claim dividends paid years after receipt.
‘‘The accountant’s problem is essentially one of reconciling cash receipts with revenues and cash disbursements with expenses. That is, for every revenue recognized but not received in cash during the current period, an asset of equal value must be recorded (or a liability must be amortized); for every expense recognized but not paid in cash in the current period, a liability of equal value must be recognized but not paid in cash in the current period, a liability of equal value must be recognized (or an asset must be amortized).’’
Required
a. Income determination is an exact science. Comment.
b. Cash flow must be estimated. Comment.
c. In the long run, cash receipts from operations is equal to revenue from operations. Comment.
d. Assume that a firm has a negative cash flow from operations in the short run. How could this negative cash flow from operations be compensated for in the short run? Discuss.
e. Assume that the reported operating income has been substantially more than the cash flow from operations for the past two years. Comment on what will need to happen to future cash flow from operations in order for the past reported income to hold up.
The data in this case come from the financial reports of Amazon.com, Inc.*
SELECTED CONSOLIDATED BALANCE SHEET ITEMS (In millions, except market price)
December 31,
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
Total current assets
$6,157
$5,164
$3,373
$2,929
$2,539
$1,821
$1,616
$1,208
$1,361
$1,012
Total assets
8,314
6,485
4,363
3,696
3,249
2,162
1,990
1,637
2,135
2,471
Total current liabilities
4,746
3,714
2,532
1,899
1,620
1,253
1,066
921
975
739
Long term debt and other
896
1,574
1,400
1,551
1,855
1,945
2,277
2,156
2,127
1,466
Total liabilities
5,642
5,288
3,932
3,450
3,475
3,198
3,343
3,077
3,102
2,205
Stockholders’ (deficit) equity
2,672
1,197
431
246
227
1,036
1,353
1,440
967
266
Total liabilities and stockholders’ equity
8,314
6,485
4,363
3,696
3,249
2,162
1,990
1,637
2,135
2,471
Outstanding shares of common stock
428
416
414
416
410
403
388
373
357
345
Market price common stock
51.28
92.64
39.46
47.15
44.29
52.62
18.89
10.82
15.56
76.12
SELECTED CONSOLIDATED STATEMENT OF OPERATIONS ITEMS (In millions, except fully diluted earnings per share)
Year Ended December 31,
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
Net sales
$19,166
$14,835
$10,711
$8,490
$6,921
$5,264
$3,933
$3,122
$2,762
$1,640
$610
Gross profit
4,270
3,353
2,456
2,039
1,602
1,257
993
799
656
291
114
Net income
(loss)
645
476
190
359
588
35
149
567
1,411
720
125
Fully diluted
earnings
per share
1.49
1.12
0.45
0.78
1.39
0.08
0.4
1.53
4.02
2.2
0.42
SELECTED CONSOLIDATED STATEMENT OF CASH FLOW ITEMS (In millions)
Year Ended December 31,
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
Net cash provided (used) in operating activities
$1,697
$1,405
$702
$703
$566
$393
$174
$120
($130)
($91)
$31
Net cash provided (used) in investing activities
1,199
42
333
778
317
236
122
253
164
932
324
Net cash provided (used) in financing activities
198
50
400
193
97
332
107
107
693
1,140
254
Cash and cash equivalents, end of period
2,769
2,539
1,022
1,013
1,303
1,102
738
540
822
133
72
Required
a. Amazon had a deficit in stockholders’ equity from 2000–2004. During this time period, Amazon increased cash and cash equivalents, end of period. Comment on how this was accomplished.
b. Compute the debt ratio for the period 1999–2008. Comment on the results.
c. Comment on the importance of net cash provided by financing activities 1998–2002.
d. Comment on the trend in net cash provided by operating activities 2000–2008.
e. Comment on the trend in net sales vs. the trend in net income (loss).
f. Comment on the market decline between 1999 and 2001.
1. Compute the total stock market price (outstanding shares of common X market price per share) for the period 1999–2008.
2. Compare the total stock market price on f(1) with the stockholders’ equity. Comment.
g. Compute the price/earnings ratio for the period 1999–2008.
h. Does the future look good for Amazon.com? Comment.
With this case, we review the profitability of several specialty retail stores. The companies reviewed and the year end dates are as follows:
1. Abercrombie & Fitch Co.
(January 31, 2009—52 week; February 2, 2008—52 week; February 3, 2007—53 week) ‘‘Abercrombie & Fitch Co. …is a specialty retailer that operates stores and websites selling casual sportswear apparel.’’ 10 K
2. Limited Brands, Inc.
(January 31, 2009—52 week; February 2, 2008—52 week; February 3, 2007—53 week) ‘‘We operate in the highly competitive specialty retail business.’’ 10 K
3. GAP, Inc.
(January 31, 2009—52 week; February 2, 2008—52 week; February 3, 2007—53 week) ‘‘We are a global specialty retailer offering clothing, accessories, and personal care products.’’ 10 K
Abercrombie & Fitch
Limited Brands
GAP
Data reviewed
2009
2008
2009
2008
2009
2008
Net cash provided by operating activities
$490,836,000
$817,524,000
$954,000,000
$765,000,000
$1,412,000,000
$2,081,000,000
Net income
$272,255,000
$475,697,000
$220,000,000
$718,000,000
$967,000,000
$833,000,000
Operating cash flow/current maturities of long term debt and current notes payable
*
*
*
*
28.24 times
15.08 times
Operating cash flow/total debt
48.96%
86.12%
18.71%
14.66%
44.44%
58.39%
Operating cash flow per share
$5.50
$8.93
$2.83
$2.01
$1.96
$2.62
Operating cash flow/cash dividends
8.08 times
13.33 times
4.75 times
3.37 times
5.81 times
8.26 times
Required
a. Comment on the difference between net cash provided by operating activities and net income.
Speculate on which number is likely to be the better indicator of long term profitability.
b. Comment on the data reviewed for each firm.
c. Do any of these firms appear to have a cash flow problem? Comment.
With this case, we review the cash flow of several restaurant companies. The restaurant companies reviewed and the year end dates are as follows:
1. Yum Brands, Inc.
(December 30, 2008; December 30, 2007)
‘‘Through the five concepts of KFC, Pizza Hut, Taco Bell, LJS and A & W (the ‘‘Concepts’’) the company develops, operates, franchises and licenses a world system of restaurants which prepare, package and sell a menu of competitively priced food items.’’ 10 K
2. Panera Bread
(December 30, 2008; December 25, 2007)
‘‘As of December 30, 2008, Panera operated and through franchise agreements with 39 franchisee groups, 1,252 cafes.’’ 10 K
3. Starbucks
(September 28, 2008; September 30, 2007)
‘‘Starbucks Corporation was formed in 1985 and today is the world’s leading roaster and retailer of specialty coffee.’’ 10 K
Yum Brands, Inc.
Panera Bread
Starbucks*
Data Reviewed
2008
2007
2008
2007
2008
2007
(In millions)
(In thousands)
(In millions)
Net cash provided by operating activities
1,521
1,551
156,282
154,014
1,258.70
1,331.20
Net income
964
909
67,436
57,456
315.5
672.6
Operating cash flow/current maturities of long term debt and current notes payable
60.84
5.39
No current maturities of long term debt and current notes payable
176.36*
187.20*
Operating cash flow/total debt
22.92
25.64
87.43
60.97
39.56
43.51
Operating cash flow per share
3.1
2.87
5.14
4.79
1.7
1.73
Operating cash flow/cash dividends
4.72
5.68
No cash dividends
No cash dividends
Required
a. Comment on the difference between net cash provided by operating activities and net income.
Speculate on which number is likely to be the better indicator of long term profitability.
b. Comment on the data reviewed for each firm.
c. Do any of these firms appear to have a cash flow problem? Comment.
1. Commercial loan officers regard profitability financial ratios as very significant. Comment.
2. Which two financial ratios do commercial loan officers regard as the most significant? Which two financial ratios appear most frequently in loan agreements?
3. The commercial loan officers did not list the dividend payout ratio as a highly significant ratio, but they did indicate that the dividend payout ratio appeared frequently in loan agreements. Speculate on the reason for this apparent inconsistency.
4. Corporate controllers regard profitability financial ratios as very significant. Comment.
5. List the top five financial ratios included in corporate objectives according to the study reviewed in this book. Indicate what each of these ratios primarily measures.
1. All firms are required to expense R&D costs incurred each period. Some firms spend very large sums on R&D, while others spend little or nothing on this area. Why is it important to observe whether a firm has substantial or immaterial R&D expenses?
2. Indicate some possible uses of a reliable model that can be used to forecast financial failure.
3. Describe what is meant by a firm’s financial failure.
4. According to the Beaver study, which ratios should be watched most closely, in order of their predictive power?
5. According to the Beaver study, three current asset accounts should be given particular attention in order to forecast financial failure. List each of these accounts and indicate whether they should be abnormally high or low.
1. What does a Z score below 2.675 indicate, according to the Altman model?
2. Indicate a practical problem with computing a Z score for a closely held firm.
3. No conclusive model has been developed to forecast financial failure. This indicates that financial ratios are not helpful in forecasting financial failure. Comment.
4. You are the auditor of Piedmore Corporation. You determine that the accounts receivable turnover has been much slower this period than in prior periods and that it is also materially lower than the industry average. How might this situation affect your audit plan?
5. You are in charge of preparing a comprehensive budget for your firm. Indicate how financial ratios can help determine an acceptable comprehensive budget.
Thorpe Company is a wholesale distributor of professional equipment and supplies. The company’s sales have averaged about $900,000 annually for the three year period 2007–2009. The firm’s total assets at the end of 2009 amounted to $850,000.
The president of Thorpe Company has asked the controller to prepare a report that summarizes the financial aspects of the company’s operations for the past three years. This report will be presented to the board of directors at its next meeting.
In addition to comparative financial statements, the controller has decided to present a number of relevant financial ratios that can assist in the identification and interpretation of trends. At the request of the controller, the accounting staff has calculated the following ratios for the three year period 2007–2009:
Ratio
2007
2008
2009
Current ratio
2
2.13
2.18
Acid test (quick) ratio
1.2
1.1
0.97
Accounts receivable turnover
9.72
8.57
7.13
Inventory turnover
5.25
4.8
3.8
Percent of total debt to total assets
44.00%
41.00%
38.00%
Percent of long term debt to total assets
25.00%
22.00%
19.00%
Sales to fixed assets (fixed asset turnover)
1.75
1.88
1.99
Sales as a percent of 2007 sales
100.00%
103.00%
106.00%
Gross profit percentage
40.00%
33.60%
38.50%
Net income to sales
7.80%
7.80%
8.00%
Return on total assets
8.50%
8.60%
8.70%
Return on stockholders’ equity
15.10%
14.60%
14.10%
In preparing his report, the controller has decided first to examine the financial ratios independently of any other data to determine whether the ratios themselves reveal any significant trends over the first three year period.
Required
a. The current ratio is increasing, while the acid test (quick) ratio is decreasing. Using the ratios provided, identify and explain the contributing factor(s) for this apparently divergent trend.
b. In terms of the ratios provided, what conclusion(s) can be drawn regarding the company’s use of financial leverage during the 2007–2009 period?
c. Using the ratios provided, what conclusion(s) can be drawn regarding the company’s net investment in plant and equipment?
Source: Materials identified as CFA Examination I, June 4, 1988, June 6, 1987 and June 6, 1988 are reproduced with permission from the Association for Investment Management and Research and the Institute of Chartered Financial Analysts.
L. Konrath Company is considering extending credit to D. Hawk Company. L. Konrath Company estimated that sales to D. Hawk Company would amount to $2 million each year. L. Konrath Company, a wholesaler, sells throughout the Midwest. D. Hawk Company, a retail chain operation, has a number of stores in the Midwest. L. Konrath Company has had a gross profit of approximately 60% in recent years and expects to have a similar gross profit on the D. Hawk Company order. The D. Hawk Company order is approximately 15% of L. Konrath Company’s present sales. Data from recent statements of D. Hawk Company follow:
(In millions)
2007
2008
2009
Assets
Current assets:
Cash
$2.60
$1.80
$1.60
Government securities (cost)
0.4
0.2
—
Accounts and notes receivable (net)
8
8.5
8.5
Inventories
2.8
3.2
2.8
Prepaid assets
0.7
0.6
0.6
Total current assets
14.5
14.3
13.5
Property, plant, and equipment (net)
4.3
5.4
5.9
Total assets
$18.80
$19.70
$19.40
Liabilities and Equities
Current liabilities
$6.90
$8.50
$9.30
Long term debt, 6%
3
2
1
Total liabilities
9.9
10.5
10.3
Shareholders’ equity
8.9
9.2
9.1
Total liabilities and equities
$18.80
$19.70
$19.40
Income
Net sales
$24.20
$24.50
$24.90
Cost of goods sold
16.9
17.2
18
Gross margin
7.3
7.3
6.9
Selling and administrative expenses
6.6
6.8
7.3
Earnings (loss) before taxes
0.7
0.5
0.4
Income taxes
0.3
0.2
0.2
Net income
$0.40
$0.30
($0.20)
Required
a. Calculate the following for D. Hawk Company for 2009:
1. Rate of return on total assets
2. Acid test ratio
3. Return on sales
4. Current ratio
5. Inventory turnover
b. As part of the analysis to determine whether L. Konrath Company should extend credit to D. Hawk Company, assume the ratios were calculated from D. Hawk Company statements. For each ratio, indicate whether it is a favorable, an unfavorable, or a neutral statistic in the decision to grant D. Hawk Company credit. Briefly explain your choice in each case.
Ratio
2007
2008
2009
Rate of return on total assets
1.96%
1.12%
0.87%
Return on sales
1.69%
0.99%
0.69%
Acid test ratio
1.73
1.36
1.19
Current ratio
2.39
1.92
1.67
Inventory turnover (times per year)
4.41
4.32
4.52
Equity relationships:
Current liabilities
36.00%
43.00%
48.00%
Long term liabilities
16
10.5
5
Shareholders’ equity
48
46.5
47
100.00%
100.00%
100.00%
Asset relationships:
Current assets
77.00%
72.50%
69.50%
Property, plant, and equipment
23
27.5
30.5
100.00%
100.00%
100.00%
c. Would you grant credit to D. Hawk Company? Support your answer with facts given in the problem.
d. What additional information, if any, would you want before making a final decision?
For each of the following numbered items, you are to select the lettered item(s) that indicate( s) its effect(s) on the corporation’s statements. If more than one effect is applicable to a particular item, be sure to indicate all applicable letters. (Assume that the state statutes do not permit declaration of nonliquidating dividends except from earnings.)
Item
Effect
1. Declaration of a cash dividend due in one month on noncumulative preferred stock
a. Reduces working capital
2. Declaration and payment of an ordinary stock dividend
b. Increases working capital
3. Receipt of a cash dividend, not previously recorded, on stock of another corporation
c. Reduces current ratio
4. Passing of a dividend on cumulative preferred stocks
d. Increases current ratio
5. Receipt of preferred shares as a dividend on stock held as a temporary investment. This was not a regularly recurring dividend.
e. Reduces the dollar amount of total capital stock
6. Payment of dividend mentioned in (1)
f. Increases the dollar amount of total capital stock
7. Issue of new common shares in a 5 for 1 stock split
Ratio of accumulated depreciation to cost of fixed assets
1 to 3
Ratio of accounts receivable to accounts payable
1.5 to 1
Ratio of working capital to stockholders’ equity
1 to 1.6
Ratio of total debt to stockholders’ equity
1 to 2
The corporation had a net income of $120,000 for 2009, which resulted in earnings of $5.20 per share of common stock. Additional information includes the following:
Capital stock authorized, issued (all in 2000), and outstanding:
Common, $10 per share par value, issued at 10% premium
Preferred, 6% nonparticipating, $100 per share par value, issued at a 10% premium Market value per share of common at December 31, 2009: $78
Preferred dividends paid in 2009: $3,000
Times interest earned in 2009: 33
The amounts of the following were the same at December 31, 2009 as at January 1, 2009:
inventory, accounts receivable, 5% bonds payable—due 2017, and total stockholders’ equity.
All purchases and sales were on account.
Required
a. Prepare in good form the condensed balance sheet and income statement for the year ending December 31, 2009, presenting the amounts you would expect to appear on Argo’s financial statements (ignoring income taxes). Major captions appearing on Argo’s balance sheet are current assets, fixed assets, intangible assets, current liabilities, long term liabilities, and stockholders’ equity. In addition to the accounts divulged in the problem, you should include accounts for prepaid expenses, accrued expenses, and administrative expenses. Supporting computations should be in good form.
b. Compute the following for 2009. (Show your computations.)
The statement of financial position for Paragon Corporation at November 30, 2009, the end of its current fiscal year, follows. The market price of the company’s common stock was $4 per share on November 30, 2009.
(In thousands)
Assets
Current assets:
Cash
$6,000
Accounts receivable
$7,000
Less: Allowance for doubtful accounts
400
6,600
Merchandise inventory
16,000
Supplies on hand
400
Prepaid expenses
1,000
Total current assets
Property, plant, and equipment:
Land
27,500
Building
$36,000
Less: Accumulated depreciation
13,500
22,500
Total property, plant, and equipment
50,000
Total assets
$80,000
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable
$6,400
Accrued interest payable
800
Accrued income taxes payable
2,200
Accrued wages payable
600
Deposits received from customers
2,000
Total current liabilities
$12,000
Long term debt:
Bonds payable—20 year, 8% convertible debentures due
20,000
December 1, 2014 (Note 7)
Less: Unamortized discount
200
19,800
Total liabilities
31,800
Stockholders’ equity:
Common stock—authorized 40,000,000 shares of $1 par value; 20,000,000 shares issued and outstanding
20,000
Paid in capital in excess of par value
12,200
Total paid in capital
32,200
Retained earnings
16,000
Total stockholders’ equity
48,200
Total liabilities and stockholders’ equity
$80,000
All items are to be considered independent of one another, and any transactions given in the items are to be considered the only transactions to affect Paragon Corporation during the just completed current or coming fiscal year. Average balance sheet account balances are used in computing ratios involving income statement accounts. Ending balance sheet account balances are used in computing ratios involving only balance sheet items.
Required Answer the following multiple choice questions:
a. If Paragon paid back all of the deposits received from customers, its current ratio would be
1. 2.50 to 1.00.
2. 2.80 to 1.00.
3. 2.33 to 1.00.
4. 3.00 to 1.00.
5. 2.29 to 1.00.
b. If Paragon paid back all of the deposits received from customers, its quick (acid test) ratio would be
1. 1.06 to 1.00.
2. 1.00 to 1.00.
3. 0.88 to 1.00.
4. 1.26 to 1.00.
5. 1.20 to 1.00.
c. A 2 for 1 common stock split by Paragon would
1. Result in each $1,000 bond being convertible into 600 new shares of Paragon common stock.
2. Decrease the retained earnings due to the capitalization of retained earnings.
3. Not affect the number of common shares outstanding.
4. Increase the total paid in capital.
5. Increase the total stockholders’ equity.
d. Paragon Corporation’s building is being depreciated using the straight line method, salvage value of $6,000,000, and life of 20 years. The number of years the building has been depreciated by Paragon as of November 30, 2009 is
1. 7.5 years.
2. 12.5 years.
3. 9.0 years.
4. 15.0 years.
5. None of these.
e. Paragon’s book value per share of common stock as of November 30, 2009 is
1. $4.00.
2. $1.61.
3. $1.00.
4. $2.41.
5. None of these.
f. If, during the current fiscal year ending November 30, 2009, Paragon had sales of $90,000,000 with a gross profit of 20% and an inventory turnover of five times per year, the merchandise inventory balance on December 1, 2008 was
1. $14,400,000.
2. $12,800,000.
3. $18,000,000.
4. $20,000,000.
5. $16,000,000.
g. If Paragon has a payout ratio of 80%and declared and paid $4,000,000 of cash dividends during the current fiscal year endedNovember 30, 2009, the retained earnings balance on December 1, 2008 was
Calcor Company has been a wholesale distributor of automobile parts for domestic automakers for 20 years. Calcor has suffered through the recent slump in the domestic auto industry, and its performance has not rebounded to the levels of the industry as a whole. Calcor’s single step income statement for the year ended November 30, 2009, follows:
CALCOR COMPANY Income Statement For the Year Ended November 30, 2009 (thousands omitted)
Net sales
$8,400
Expenses:
Cost of goods sold
6,300
Selling expense
780
Administrative expense
900
Interest expense
140
Total
8,120
Income before income taxes
280
Income taxes
112
Net income
$168
Calcor’s return on sales before interest and taxes was 5% in fiscal 2009 compared with the industry average of 9%. Calcor’s turnover of average assets of four times per year and return on average assets before interest and taxes of 20% are both well below the industry average.
Joe Kuhn, president of Calcor, wishes to improve these ratios and raise them nearer to the industry averages. He established the following goals for Calcor Company for fiscal 2010:
Return on sales before interest and taxes
8%
Turnover of average assets
times per year
Return on average assets before interest and taxes
30%
For fiscal 2010, Kuhn and the rest of Calcor’s management team are considering the following actions, which they expect will improve profitability and result in a 5% increase in unit sales:
1. Increase selling prices 10%.
2. Increase advertising by $420,000 and hold all other selling and administrative expenses at fiscal 2009 levels.
3. Improve customer service by increasing average current assets (inventory and accounts receivable) by a total of $300,000, and hold all other assets at fiscal 2009 levels.
4. Finance the additional assets at an annual interest rate of 10% and hold all other interest expense at fiscal 2009 levels.
5. Improve the quality of products carried; this will increase the units of goods sold by 4%.
6. Calcor’s 2010 effective income tax rate is expected to be 40%—the same as in fiscal 2009.
Required
a. Prepare a single step pro forma income statement for Calcor Company for the year ended November 30, 2010, assuming that Calcor’s planned actions would be carried out and that the 5% increase in unit sales would be realized.
b. Calculate the following ratios for Calcor Company for the 2009–2010 fiscal year and state whether Kuhn’s goal would be achieved:
1. Return on sales before interest and taxes
2. Turnover of average assets
3. Return on average assets before interest and taxes
c. Would it be possible for Calcor Company to achieve the first two of Kuhn’s goals without achieving his third goal of a 30% return on average assets before interest and taxes? Explain your answer.
A building acquired at the beginning of the year at a cost of $316,000 has an estimated residual value of $48,000 and an estimated useful life of 40 years. Determine (a) the depreciable cost, (b) the straight line rate, and (c) the annual straight line depreciation.
A tractor acquired at a cost of $120,000 has an estimated residual value of $5,000, has an estimated useful life of 50,000 hours, and was operated 4,200 hours during the year. Determine (a) the depreciable cost, (b) the depreciation rate, and (c) the units of production depreciation for the year.
A truck acquired at a cost of $90,000 has an estimated residual value of $18,000, has an estimated useful life of 200,000 miles, and was driven 40,000 miles during the year. Determine (a) the depreciable cost, (b) the depreciation rate, and (c) the units of production depreciation for the year.
Kelly Melnik owns and operates Aaladin Print Co. During July, Aaladin Print Co. incurred the following costs in acquiring two printing presses. One printing press was new, and the other was used by a business that recently filed for bankruptcy.
Costs related to new printing press:
1. Sales tax on purchase price
2. Insurance while in transit
3. Freight
4. Special foundation
5. Fee paid to factory representative for installation
6. New parts to replace those damaged in unloading
Costs related to used printing press:
7. Fees paid to attorney to review purchase agreement
8. Installation
9. Repair of vandalism during installation
10. Replacement of worn out parts
11. Freight
12. Repair of damage incurred in reconditioning the press
a. Indicate which costs incurred in acquiring the new printing press should be debited to the asset account.
b. Indicate which costs incurred in acquiring the used printing press should be debited to the asset account.
(January 31, 2009—52 week; February 2, 2008—52 week; February 3, 2007—53 week) ‘‘Abercrombie & Fitch Co. …is a specialty retailer that operates stores and websites selling casual sportswear apparel.’’ 10 K
2. Limited Brands, Inc.
(January 31, 2009—52 week; February 2, 2008—52 week; February 3, 2007—53 week) ‘‘We operate in the highly competitive specialty retail business.’’ 10 K
3. GAP, Inc.
(January 31, 2009—52 week; February 2, 2008—52 week; February 3, 2007—53 week) ‘‘We are a global specialty retailer offering clothing, accessories, and personal care products.’’ 10 K
Data reviewed
Abercrombie & Fitch
Limited Brands
GAP
2009
2008
2009
2008
2009
2008
All inclusive degree of financial coverage
*
*
1.4
1.13
1
1.02
Diluted earnings per share before nonrecurring items
3.05
5.2
0.65
1.89
1.34
1.09
Percentage of earnings retained
77.68
87.11
8.64
68.38
74.87
70.93
Dividend yield
3.92
0.85
7.58
3.1
3.01
1.65
Price/earnings ratio
5.85
15.78
12.18
10.23
8.42
17.74
Market price per share
17.85
82.06
7.92
19.33
11.28
19.34
Required
a. Comment on all data reviewed for each individual company.
b. Based on the above, which firm would you select?
With this case, we review the profitability of several restaurant companies. The restaurant companies reviewed and the year end dates are as follows:
1. Yum Brands, Inc.
(December 30, 2008; December 30, 2007)
‘‘Through the five concepts of KFC, Pizza Hut, Taco Bell, LJS and A & W (the ‘‘Concepts’’) the company develops, operates, franchises and licenses a world system of restaurants which prepare, package and sell a menu of competitively priced food items.’’ 10 K
2. Panera Bread
(December 30, 2008; December 25, 2007)
‘‘As of December 30, 2008, Panera operated and through franchise agreements with 39 franchisee groups, 1,252 cafes.’’ 10 K
3. Starbucks
(September 28, 2008; September 30, 2007)
‘‘Starbucks Corporation was formed in 1985 and today is the world’s leading roaster and retailer of specialty coffee.’’ 10 K
Data Reviewed
Yum Brands, Inc.
Panera Bread
Starbucks*
2008
2007
2008
2007
2008
2007
All inclusive degree of financial leverage
1.18
1.14
101.46
100.55
115.44
104.01
Diluted earnings per share before nonrecurring items
$1.96
$1.68
$2.22
$1.79
$0.43
$0.87
Percentage of earnings retained
66.60%
69.97%
100.00%
100.00%
100.00%
100.00%
Dividend yield
2.33%
1.17%
0
0
0
0
Price/earnings ratio
15.77
22.94
22.62
20.32
34.79
30.11
Market price per share
30.91
38.54
50.22
36.37
14.96
26.2
Required
a. Comment on all the data reviewed for each individual company for 2008 and 2007.
b. Based on the above, which firm would you select?
1. There are two principal methods of presenting cash flow from operating activities—the direct method and the indirect method. Describe these two methods.
2. Depreciation expense, amortization of patents, and amortization of bond discount are examples of items that are added to net income when using the indirect method of presenting cash flows from operating activities. Amortization of premium on bonds and a reduction in deferred taxes are examples of items that are deducted from net income when using the indirect method of presenting cash flows from operating activities. Explain why these adjustments to net income are made to compute cash flows from operating activities.
3. What is the meaning of the term cash in the statement of cash flows?
4. What is the purpose of the statement of cash flows?
5. Why is it important to disclose certain noncash investing and financing transactions, such as exchanging common stock for land?
The income statement and other selected data for Boyer Company follow:
BOYER COMPANY Income Statement For Year Ended December 31, 2009
Sales
$19,000
Operating expenses:
Depreciation expense
$2,300
Other operating expenses
12,000
14,300
Operating income
4,700
Loss on sale of land
1,500
Income before tax expense
3,200
Tax expense
1,000
Net income
$2,200
Supplemental information:
a. Dividends declared and paid
$800
b. Land purchased
3,000
c. Land sold
500
d. Equipment purchased
2,000
e. Bonds payable retired
2,000
f. Common stock sold
1,400
g. Land acquired in exchange for common stock
3,000
h. Increase in accounts receivable
400
i. Increase in inventories
800
j. Increase in accounts payable
500
k. Decrease in income taxes payable
400
Required
a. Prepare a schedule of change from an accrual basis to a cash basis income statement.
b. Using the schedule of change from accrual basis to cash basis income statement computed in (a), present the cash provided by operations, using (1) the direct approach and (2) the indirect approach.
Arrowbell Company is a growing company. Two years ago, it decided to expand in order to increase its production capacity. The company anticipates that the expansion program can be completed in another two years. Financial information for Arrowbell is as follows.
ARROWBELL COMPANY Sales and Net Income
Year
Sales
Net Income
2005
$2,568,660
$145,800
2006
2,660,455
101,600
2007
2,550,180
52,650
2008
2,625,280
86,800
2009
3,680,650
151,490
ARROWBELL COMPANY Balance Sheet December 31, 2009 and 2008
2009
2008
Assets
Current assets:
Cash
$250,480
$260,155
Accounts receivable (net)
760,950
690,550
Inventories at lower of cost or market
725,318
628,238
Prepaid expenses
18,555
20,250
Total current assets
1,755,303
1,599,193
Plant and equipment:
Land, buildings, machinery, and equipment
3,150,165
2,646,070
Less: Accumulated depreciation
650,180
525,650
Net plant and equipment
2,499,985
2,120,420
Other assets:
Cash surrender value of life insurance
20,650
18,180
Other
40,660
38,918
Total other assets
61,310
57,098
Total assets
$4,316,598
$3,776,711
Liabilities and Stockholders’ Equity
Current liabilities:
Notes and mortgages payable, current portion
$915,180
$550,155
Accounts payable and accrued liabilities
1,160,111
851,080
Total current liabilities
2,075,291
1,401,235
Long term notes and mortgages payable, less current portion above
550,000
775,659
Total liabilities
2,625,291
2,176,894
Stockholders’ equity:
Capital stock, par value $1.00; authorized, 800,000; issued and outstanding, 600,000 (2009 and 2008)
600,000
600,000
Paid in excess of par
890,000
890,000
Retained earnings
201,307
109,817
Total stockholders’ equity
1,691,307
1,599,817
Total liabilities and stockholders’ equity
$4,316,598
$3,776,711
ARROWBELL COMPANY Statement of Cash Flows For Years Ended December 31, 2009 and 2008
2009
2008
Cash flows from operating activities:
Net income
$151,490
$86,800
Noncash expenses, revenues, losses, and gains included in income:
Depreciation
134,755
102,180
Increase in accounts receivable
70,400
10,180
Increase in inventories
97,080
15,349
Decrease in prepaid expenses in 2009, increase in 2008
1,695
1,058
Increase in accounts payable and accrued liabilities
309,031
15,265
Net cash provided by operating activities
429,491
177,658
Cash flows from investing activities:
Proceeds from retirement of property, plant, and equipment
10,115
3,865
Purchases of property, plant, and equipment
524,435
218,650
Increase in cash surrender value of life insurance
2,470
1,848
Other
1,742
1,630
Net cash used for investing activities
518,532
218,263
Cash flows from financing activities:
Retirement of long term debt
225,659
50,000
Increase in notes and mortgages payable
365,025
159,155
Cash dividends
60,000
60,000
Net cash provided by financing activities
79,366
49,155
Net increase (decrease) in cash
($9,675)
$8,550
Required
a. Comment on the short term debt position, including computations of current ratio, acid test ratio, cash ratio, and operating cash flow/current maturities of long term debt and current notes payable.
b. If you were a supplier to this company, what would you be concerned about?
c. Comment on the long term debt position, including computations of the debt ratio, debt/equity, debt to tangible net worth, and operating cash flow/total debt. Review the statement of operating cash flows.
d. If you were a banker, what would you be concerned about if this company approached you for a long term loan to continue its expansion program?
e. What should management consider doing at this point with regard to the company’s expansion program?
The balance sheet for December 31, 2009, income statement for the year ended December 31, 2009, and the statement of cash flows for the year ended December 31, 2009, of Bernett Company are shown in the following balance sheet.
The president of Bernett Company cannot understand why Bernett is having trouble paying current obligations. He notes that business has been very good, as sales have more than doubled, and the company achieved a profit of $69,000 in 2009.
BERNETT COMPANY Balance Sheet December 31, 2009 and 2008
2009
2008
Assets
Cash
$5,000
$28,000
Accounts receivable, net
92,000
70,000
Inventory
130,000
85,000
Prepaid expenses
4,000
6,000
Land
30,000
10,000
Building
170,000
30,000
Accumulated depreciation
20,000
10,000
Total assets
$411,000
$219,000
Liabilities and Stockholders’ Equity
Accounts payable
$49,000
$44,000
Income taxes payable
5,000
4,000
Accrued liabilities
6,000
5,000
Bonds payable (current $10,000 at 12/31/09)
175,000
20,000
Common stock
106,000
96,000
Retained earnings
70,000
50,000
Total liabilities and stockholders’ equity
$411,000
$219,000
BERNETT COMPANY Income Statement For Year Ended December 31, 2009
Sales
$500,000
Less expenses:
Cost of goods sold (includes depreciation of $4,000)
310,000
Selling and administrative expenses (includes depreciation of $6,000)
80,000
Interest expense
11,000
Total expenses
401,000
Income before taxes
99,000
Income tax expense
30,000
Net income
$69,000
BERNETT COMPANY Statement of Cash Flows For Year Ended December 31, 2009
Net cash flow from operating activities:
Net income
$69,000
Noncash expenses, revenues, losses, and gains included in income:
Depreciation
10,000
Increase in receivables
22,000
Increase in inventory
45,000
Decrease in prepaid expenses
2,000
Increase in accounts payable
5,000
Increase in income taxes payable
1,000
Increase in accrued liabilities
1,000
Net cash flow from operating activities
$21,000
Cash flows from investing activities:
Increase in land
($20,000)
Increase in buildings
140,000
Net cash used by investing activities
160,000
Cash flows from financing activities:
Bond payable increase
$155,000
Common stock increase
10,000
Cash dividends paid
49,000
Net cash provided by financing activities
116,000
Net decrease in cash
($23,000)
Required
a. Comment on the statement of cash flows.
b. Compute the following liquidity ratios for 2009:
1. Current ratio
2. Acid-test ratio
3. Operating cash flow/current maturities of long-term debt and current notes payable
4. Cash ratio
c. Compute the following debt ratios for 2009:
1. Times interest earned
2. Debt ratio
3. Operating cash flow/total debt
d. Compute the following profitability ratios for 2009:
1. Return on assets (using average assets)
2. Return on common equity (using average common equity)
e. Compute the following investor ratio for 2009: Operating cash flow/cash dividends.
f. Give your opinion as to the liquidity of Bernett.
g. Give your opinion as to the debt position of Bernett.
h. Give your opinion as to the profitability of Bernett.
i. Give your opinion as to the investor ratio.
j. Give your opinion of the alternatives Bernett has in order to ensure that it can pay bills as they come due.
Consider the following data for three different companies:
($000 Omitted)
Owens
Arrow
Alpha
Net cash provided (used) by:
Operating activities
($2,000)
$2,700
($3,000)
Investing activities
6,000
600
400
Financing activities
9,000
400
2,600
Net increase (decrease) in cash
$1,000
$1,700
($6,000)
The patterns of cash flows for these firms differ. One firm is a growth firm that is expanding rapidly, another firm is in danger of bankruptcy, while another firm is an older firm that is expanding slowly.
Required
Select the growth firm, the firm in danger of bankruptcy, and the firm that is the older firm expanding slowly. Explain your selection.
Webster Corporation’s statement of cash flows for the year ended December 31, 2009, was prepared using the indirect method, and it included the following items:
Net income
$100,000
Noncash adjustments:
Depreciation expense
20,000
Decrease in accounts receivable
8,000
Decrease in inventory
25,000
Increase in accounts payable
10,000
Net cash flows from operating activities
$163,000
Required
a. What amount of cash did Webster receive from customers during the year ended December 31, 2009?
b. Did depreciation expense provide cash inflow? Comment.
ARDEN GROUP, INC., AND CONSOLIDATED SUBSIDIARIES* CONSOLIDATED STATEMENTS OF CASH FLOWS
Fifty Three Weeks Ended January 3, 2009
Fifty Two Weeks Ended December 29, 2007
Fifty Two Weeks Ended December 30, 2006
(In thousands)
Cash flows from operating activities:
Cash received from customers
$479,578
$485,819
$482,645
Cash paid to suppliers and employees
437,970
438,044
440,735
Interest and dividends received
2,513
3,186
2,580
Interest paid
109
99
125
Income taxes paid
15,545
20,660
17,645
Net cash provided by operating activities
28,467
30,202
26,720
Cash flows from investing activities:
Capital expenditures
5,159
3,824
4,868
Purchases of investments
25,130
945
827
Sales of investments
35,556
2
2,751
Proceeds from the sale of property, plant and equipment
21
28
215
Net cash provided by (used) in investing activities
5,288
4,739
2,279
Cash flows from financing activities:
Purchase and retirement of Company stock
0
0
19,999
Principal payments under capital lease obligations
0
225
221
Cash dividends paid
82,188
3,161
3,267
Net cash used in financing activities
82,188
3,386
23,487
Net increase (decrease) in cash and cash equivalents
48,433
22,077
504
Cash and cash equivalents at beginning of year
58,919
36,842
36,338
Cash and cash equivalents at end of year
$10,486
$58,919
$36,842
Required
a. Prepare the statement of cash flows, with a total column for the three year period. (Do not include reconciliation).
b. Comment on significant cash flow items in the statement prepared in (a).
c. Prepare the statement of cash flows for 2009, with inflows separated from outflows. Present the data in dollars and percentages. Do not include reconciliation of net income to net cash provided by operating activities.
d. Comment on significant cash flow items on the statement prepared in (c).
The series of seven transactions recorded in the following T accounts were related to a sale to a customer on account and the receipt of the amount owed. Briefly describe each transaction.
Polo Ralph Lauren Corporation designs, markets, and distributes a variety of apparel, home decor, accessory, and fragrance products. The company’s products include such brands as Polo by Ralph Lauren, Ralph Lauren Purple Label, Ralph Lauren, Polo Jeans Co., and Chaps.
Polo Ralph Lauren reported the following (in thousands):
For the Period Ending
April 2, 2005
April 3, 2004
Net sales
$3,305,415
$2,649,654
Accounts receivable
530,503
463,289
Assume that accounts receivable (in millions) were $391,558 at the beginning of the 2004 fiscal year.
a. Compute the accounts receivable turnover for 2005 and 2004. Round to one decimal place.
b. Compute the days’ sales in receivables for 2005 and 2004. Round to one decimal place.
c. What conclusions can be drawn from these analyses regarding Ralph Lauren’s efficiency in collecting receivables?
H.J. Heinz Company was founded in 1869 at Sharpsburg, Pennsylvania, by Henry J. Heinz. The company manufactures and markets food products throughout the world, including ketchup, condiments and sauces, frozen food, pet food, soups, and tuna. For the fiscal years 2005 and 2004, H.J. Heinz reported the following (in thousands):
Year Ending
April 27, 2005
April 28, 2004
Net sales
$8,912,297
$8,414,538
Account receivable
1,092,394
1,093,155
Assume that the accounts receivable (in thousands) were $1,165,460 at the beginning of 2004.
a. Compute the accounts receivable turnover for 2005 and 2004. Round to one decimal place.
b. Compute the days’ sales in receivables at the end of 2005 and 2004. Round to one decimal place.
c. What conclusions can be drawn from these analyses regarding Heinz’s efficiency in collecting receivable
The Limited, Inc., sells women’s and men’s clothing through specialty retail stores, including The Limited, Express, and Lane Bryant. The Limited sells women’s intimate apparel and personal care products through Victoria’s Secret and Bath & Body Works stores. The Limited reported the following (in millions):
For the Period Ending
Jan. 31, 2006
Jan. 29, 2005
Net sales
$9,699
$9,408
Account receivable
182
128
Assume that accounts receivable (in millions) were $110 on February 1, 2004.
a. Compute the accounts receivable turnover for 2006 and 2005. Round to one decimal place.
b. Compute the day’s sales in receivables for 2006 and 2005. Round to one decimal place.
c. What conclusions can be drawn from these analyses regarding The Limited’s efficiency in collecting receivables?
The following transactions were completed by Clark Management Company during the current fiscal year ended December 31:
July 5.
Received 70% of the $21,000 balance owed by Dockins Co., a bankrupt business,
and wrote off the remainder as uncollectible.
Sept. 21.
Reinstated the account of Bart Tiffany, which had been written off in the preceding
year as uncollectible. Journalized the receipt of $4,875 cash in full payment
of Tiffany’s account.
Oct. 19.
Wrote off the $6,275 balance owed by Ski Time Co., which has no assets.
Nov. 6.
Reinstated the account of Kirby Co., which had been written off in the preceding
year as uncollectible. Journalized the receipt of $4,750 cash in full payment
of the account.
Dec. 31.
Wrote off the following accounts as uncollectible (compound entry): Maxie
Co., $2,150; Kommers Co., $3,600; Helena Distributors, $5,500; Ed Ballantyne,
$1,750.00
31
Based on an analysis of the $815,240 of accounts receivable, it was estimated
that $16,750 will be uncollectible. Journalized the adjusting entry.
Instructions
1. Record the January 1 credit balance of $12,550 in a T account for Allowance for Doubtful Accounts.
2. Journalize the transactions. Post each entry that affects the following selected T accounts and determine the new balances:
Allowance for Doubtful Accounts
Bad Debt Expense
3. Determine the expected net realizable value of the accounts receivable as of December 31.
4. Assuming that instead of basing the provision for uncollectible accounts on an analysis of receivables, the adjusting entry on December 31 had been based on an estimated expense of 1⁄4 of 1% of the net sales of $7,126,000 for the year, determine the following:
a. Bad debt expense for the year.
b. Balance in the allowance account after the adjustment of December 31.
c. Expected net realizable value of the accounts receivable as of December 31.
Pegasus Company, a telephone service and supply company, has just completed its fourth year of operations. The direct write off method of recording bad debt expense has been used during the entire period. Because of substantial increases in sales volume and the amount of uncollectible accounts, the firm is considering changing to the allowance method. Information is requested as to the effect that an annual provision of 3⁄4% of sales would have had on the amount of bad debt expense reported for each of the past four years. It is also considered desirable to know what the balance of Allowance for Doubtful Accounts would have been at the end of each year. The following data have been obtained from the accounts:
Uncollectible
Year of Origin of
Accounts
Accounts Receivable Written
Written
Off as Uncollectible
Year
Sales
Off
1st
2nd
3rd
4th
1st
$ 910,000
$ 3,500
$3,500
2nd
1,064,000
4,130
2,660
$1,470
3rd
1,330,000
7,980
980
5,600
$1,400
4th
2,520,000
10,920
1,680
3,570
$5,670
Instructions
1. Assemble the desired data, using the following column headings:
Bad Debt Expense
Expense
Expense
Increase (Decrease)
Balance of
Actually
Based on
in Amount
Allowance Account,
Year
Reported
Estimate
of Expense
End of Year
2. Experience during the first four years of operations indicated that the receivables were either collected within two years or had to be written off as uncollectible.
Does the estimate of 3⁄4% of sales appear to be reasonably close to the actual experience with uncollectible accounts originating during the first two years? Explain.
The following were selected from among the transactions completed by Hunter Co. during the current year. Hunter Co. sells and installs home and business security systems.
Jan. 15.
Loaned $6,000 cash to Dan Hough, receiving a 90 day, 8% note.
Feb. 6.
Sold merchandise on account to Kent and Son, $16,000. The cost of the merchandise
sold was $9,000.
13
Sold merchandise on account to Centennial Co., $30,000. The cost of merchandise
sold was $15,750.
Mar. 5.
Accepted a 60 day, 6% note for $16,000 from Kent and Son on account.
14
Accepted a 60 day, 12% note for $30,000 from Centennial Co. on account.
Apr. 15.
Received the interest due from Dan Hough and a new 90 day, 10% note as a
renewal of the loan of January 15. (Record both the debit and the credit to the
notes receivable account.)
May 4.
Received from Kent and Son the amount due on the note of March 5.
13
Centennial Co. dishonored its note dated March 14.
June 12.
Received from Centennial Co. the amount owed on the dishonored note, plus
interest for 30 days at 12% computed on the maturity value of the note.
July 14.
Received from Dan Hough the amount due on his note of April 15.
Aug. 10.
Sold merchandise on account to Conover Co., $10,000. The cost of the merchandise
sold was $6,500.
20
Received from Conover Co. the amount of the invoice of August 10, less 1%
The following transactions were completed by The Corion Gallery during the current fiscal year ended December 31:
Mar. 21.
Reinstated the account of Tony Marshal, which had been written off in the preceding
year as uncollectible. Journalized the receipt of $4,050 cash in full payment
of Marshal’s account.
Apr. 18.
Wrote off the $5,500 balance owed by Crossroads Co., which is bankrupt.
Aug. 17.
Received 25% of the $10,000 balance owed by Raven Co., a bankrupt business,
and wrote off the remainder as uncollectible.
Oct. 10.
Reinstated the account of Elden Hickman, which had been written off two
years earlier as uncollectible. Recorded the receipt of $2,400 cash in full payment.
Dec. 31.
Wrote off the following accounts as uncollectible (compound entry): Buffalo
Co., $13,275; Combs Co., $4,000; Nash Furniture, $6,150; Tony DePuy,
$1,720.00
31
Based on an analysis of the $900,750 of accounts receivable, it was estimated
that $58,000 will be uncollectible. Journalized the adjusting entry.
Instructions
1. Record the January 1 credit balance of $41,500 in a T account for Allowance for Doubtful Accounts.
2. Journalize the transactions. Post each entry that affects the following T accounts and determine the new balances:
Allowance for Doubtful Accounts
Bad Debt Expense
3. Determine the expected net realizable value of the accounts receivable as of December 31.
4. Assuming that instead of basing the provision for uncollectible accounts on an analysis of receivables, the adjusting entry on December 31 had been based on an estimated expense of 1⁄2 of 1% of the net sales of $10,380,000 for the year, determine the following:
a. Bad debt expense for the year.
b. Balance in the allowance account after the adjustment of December 31.
c. Expected net realizable value of the accounts receivable as of December 31.
Looks Good Wigs Company supplies wigs and hair care products to beauty salons throughout California and the Pacific Northwest. The accounts receivable clerk for Looks Good prepared the following partially completed aging of receivables schedule as of the end of business on December 31, 2007:
Not
Days Past Due
Past
Customer
Balance
Due
1–30
31–60
61–90
91–120
Over 120
Daytime Beauty
20,000
20,000
Blount Wigs
11,000
11,000
Zabka’s
2,900
2,900
Subtotals
780,000
398,600
197,250
98,750
33,300
29,950
22,150
The following accounts were unintentionally omitted from the aging schedule:
Customer
Due Date
Balance
Uniquely Yours
July 1, 2007
$1,200
Paradise Beauty Store
Sept. 29, 2007
1,050
Morgan’s Hair Products
Oct. 17, 2007
800
Hairy’s Hair Care
Oct. 31, 2007
2,000
Superior Images
Nov. 18, 2007
700
Oh The Hair
Nov. 30, 2007
3,500
Mountain Coatings
Dec. 1, 2007
1,000
Theatrical Images
Jan. 3, 2008
6,200
Looks Good Wigs has a past history of uncollectible accounts by age category, as follows:
Percent
Age Class
Uncollectible
Not past due
2%
1–30 days past due
4
31–60 days past due
10
61–90 days past due
15
91–120 days past due
35
Over 120 days past due
80
Instructions
1. Determine the number of days past due for each of the preceding accounts.
2. Complete the aging of receivables schedule.
3. Estimate the allowance for doubtful accounts, based on the aging of receivables schedule.
4. Assume that the allowance for doubtful accounts for Looks Good Wigs has a credit balance of $9,550 before adjustment on December 31, 2007. Journalize the adjustment for uncollectible accounts.
Baron Company, which operates a chain of 30 electronics supply stores, has just completed its fourth year of operations. The direct write off method of recording bad debt expense has been used during the entire period. Because of substantial increases in sales volume and the amount of uncollectible accounts, the firm is considering changing to the allowance method. Information is requested as to the effect that an annual provision of 1⁄2% of sales would have had on the amount of bad debt expense reported for each of the past four years. It is also considered desirable to know what the balance of Allowance for Doubtful Accounts would have been at the end of each year. The following data have been obtained from the accounts:
Uncollectible
Year of Origin of
Accounts
Accounts Receivable Written
Written
Off as Uncollectible
Year
Sales
Off
1st
2nd
3rd
4th
1st
$ 500,000
$ 600
$ 600
2nd
750,000
1,500
700
$ 800
3rd
1,150,000
6,500
1,900
1,500
$3,100
4th
2,100,000
8,850
2,000
3,050
$3,800
Instructions
1. Assemble the desired data, using the following column headings:
Bad Debt Expense
Expense
Expense
Increase (Decrease)
Balance of
Actually
Based on
in Amount
Allowance Account,
Year
Reported
Estimate
of Expense
End of Year
2. Experience during the first four years of operations indicated that the receivables were either collected within two years or had to be written off as uncollectible. Does the estimate of 1⁄2% of sales appear to be reasonably close to the actual experience with uncollectible accounts originating during the first two years? Explain.
The following data relate to notes receivable and interest for Vidovich Co., a financial services company. (All notes are dated as of the day they are received.)
Mar. 6.
Received an $18,000, 9%, 60 day note on account.
25
Received a $10,000, 8%, 90 day note on account.
May 5.
Received $18,270 on note of March 6.
16
Received a $40,000, 7%, 90 day note on account.
31
Received a $12,000, 8%, 30 day note on account.
June 23.
Received $10,200 on note of March 25.
30
Received $12,080 on note of May 31.
July 1.
Received a $5,000, 12%, 30 day note on account.
31
Received $5,050 on note of July 1.
Aug. 14.
Received $40,700 on note of May 16.
Instructions
Journalize the entries to record the transactions.
For several years, sales have been on a “cash only” basis. On January 1, 2005, however, Litespeed Co. began offering credit on terms of n/30. The amount of the adjusting entry to record the estimated uncollectible receivables at the end of each year has been 1⁄4 of 1% of credit sales, which is the rate reported as the average for the industry. Credit sales and the year end credit balances in Allowance for Doubtful Accounts for the past four years are as follows:
Allowance for
Year
Credit Sales
Doubtful Accounts
2005
$8,160,000
$ 8,520
2006
8,400,000
15,840
2007
8,520,000
22,680
2008
8,700,000
32,820
Ursula Sykes, president of Litespeed Co., is concerned that the method used to account for and write off uncollectible receivables is unsatisfactory. She has asked for your advice in the analysis of past operations in this area and for recommendations for change.
1. Determine the amount of (a) the addition to Allowance for Doubtful Accounts and (b) the accounts written off for each of the four years.
2. a. Advise Ursula Sykes as to whether the estimate of 1⁄4 of 1% of credit sales appears reasonable.
b. Assume that after discussing (a) with Ursula Sykes, she asked you what action might be taken to determine what the balance of Allowance for Doubtful Accounts should be at December 31, 2008, and what possible changes, if any, you might recommend in accounting for uncollectible receivables. How would you respond?
Best Buy is a specialty retailer of consumer electronics, including personal computers, entertainment software, and appliances. Best Buy operates retail stores in addition to the Best Buy, Media Play, On Cue, and Magnolia Hi Fi Web sites. For the years ending February 26, 2005, and February 28, 2004, Best Buy reported the following (in millions):
Year Ending
Feb. 26, 2005
Feb. 28, 2004
Net sales
$27,433
$24,548
Accounts receivable at end of year
375
343
Assume that the accounts receivable (in millions) were $312 at the beginning of the year ending February 28, 2004.
1. Compute the accounts receivable turnover for 2005 and 2004. Round to one decimal place.
2. Compute the days’ sales in receivables at the end of 2005 and 2004.
3. What conclusions can be drawn from (1) and (2) regarding Best Buy’s efficiency in collecting receivables?
4. For its years ending in 2005 and 2004, Circuit City Stores, Inc., has an accounts receivable turnover of 61.0 and 56.3, respectively. Compare Best Buy’s efficiency in collecting receivables with that of Circuit City.
5. What assumption did we make about sales for the Circuit City and Best Buy ratio computations that might distort the two company ratios and therefore cause the ratios not to be comparable?
Apple Computer, Inc., designs, manufactures, and markets personal computers and related personal computing and communicating solutions for sale primarily to education, creative, consumer, and business customers. Substantially all of the company’s net sales over the last five years are from sales of its Apple Macintosh line of personal computers and related software and peripherals. For the fiscal years ending September 24, 2005 and September 25, 2004, Apple reported the following (in millions):
Year Ending
Sept. 24, 2005
Sept. 25, 2004
Net sales
$13,931
$8,279
Accounts receivable at end of year
895
774
Assume that the accounts receivable (in millions) were $766 at the beginning of 2004.
1. Compute the accounts receivable turnover for 2005 and 2004. Round to one decimal place.
2. Compute the days’ sales in receivables at the end of 2005 and 2004.
3. What conclusions can be drawn from (1) and (2) regarding Apple’s efficiency in collecting receivables?
4. Using the Internet, access the Apple September 25, 2004, 10 K filing with the Securities and Exchange Commission. Search the 10 K filing for the term “receivable.” Identify one company that had accounts receivable with Apple at the end of fiscal years 2005 and 2004.
EarthLink, Inc., is a nationwide Internet Service Provider (ISP). Earthlink provides a variety of services to its customers, including narrowband access, broadband or high speed access, and Web hosting services. For the years ending December 31, 2005 and 2004, Earthlink reported the following (in thousands):
Year Ending
Dec. 31, 2005
Dec. 31, 2004
Net sales
$1,290,072
$1,382,202
Accounts receivable at end of year
36,033
30,733
Assume that the accounts receivable (in thousands) were $35,585 at January 1, 2004.
1. Compute the accounts receivable turnover for 2005 and 2004. Round to one decimal place.
2. Compute the days’ sales in receivables at the end of 2005 and 2004.
3. What conclusions can be drawn from (1) and (2) regarding EarthLink’s efficiency in collecting receivables?
4. Given the nature of EarthLink’s operations, do you believe EarthLink’s accounts receivable turnover ratio would be higher or lower than a typical manufacturing company, such as Boeing or Kellogg Company? Explain.
The accounts receivable turnover ratio will vary across companies, depending upon the nature of the company’s operations. For example, an accounts receivable turnover of 6 for an Internet Services Provider is unacceptable but might be excellent for a manufacturer of specialty milling equipment. A list of well known companies follows.
Alcoa Inc.
The Coca Cola Company
Kroger
AutoZone, Inc.
Delta Air Lines
Procter & Gamble
Barnes & Noble, Inc.
The Home Depot
Wal Mart
Caterpillar
IBM
Whirlpool Corporation
1.Look up each company by entering its name. Click on each company’s name and then scroll down to the bottom of the page to “Set Preferences.” Select “Receivables Turnover” in the Ratios list. Then click “Save Preferences.”
2. Categorize each of the preceding companies as to whether its turnover ratio is above or below 15.
3. Based upon (2), identify a characteristic of companies with accounts receivable turnover ratios above 15.
Establishing a Not for Profit Organization. As a certified public accountant, you have been asked by a group of local citizens to assist in establishing a not for profit organization for the purpose of raising funds to keep their neighborhood safe and clean. These people are concerned about the growing crime rate and increased amount of trash and traffic in their community. They believe that a collaborative effort is needed to address these problems. The citizens are not sure how large the organization will be.
Required
a. Prepare a memo to the group that outlines the process involved in creating a tax exempt not for profit entity. Be sure to point out particular alternative strategies, including the advantages and disadvantages you believe the incorporating officers should spend time considering.
b. What resources are available on the Internet to help this group understand the regulatory, taxation, and performance measure issues that they will face as officers of a tax exempt, not for profit organization?
Unrelated Business Income Tax. Dan Smith is a certified human resource manager who serves on the board of a local professional association of human resource managers. The association puts on an annual conference for its members at whom there are educational workshops, keynote speakers, and a display of vendors that serve the needs of human resource managers. This year, the association has decided to allow vendors to advertise in the annual meeting publication for a fee. Mr. Smith is unsure whether the benefits of allowing this advertising outweigh the potential costs if this income is subject to unrelated business income tax. As a result, Mr. Smith has asked your assistance, as an accounting student, in analyzing the costs and benefits of this proposal.
Required
a. Create a list of questions to pose to the executive director of the association about the proposed advertising so that the board has all the relevant facts on hand.
b. What resources are available to investigate whether income from advertising is subject to unrelated business income tax?
c. Prepare a memo to Mr. Smith that outlines the key issues involved in the proposal and suggest an approach to analyzing whether the proposal is in the best interests of the professional association.
Internet Case—Performance Measures. Go to the Internet Web sites of five of the largest charitable organizations listed in Illustration 15–7 and search for financial information and performance measures they may disclose on their Web sites.
Required
a. Locate a comparable organization for each of these five NPOs, perhaps a competitor. From information provided on the Web sites, calculate the amount that each organization spent on its program (as a percentage of income and of total expenses) as well as the number of dollars it raised for each dollar spent on fund raising.
b. Select other financial performance measures from Illustration 15–6, calculate those measures, and compare pairs of organizations. Where could you get other useful information?
c. Prepare a table showing the five charities, their counterparts, and performance measures for each. Which charity would you consider the most efficient and effective? Why?
Nonfinancial Performance Measures. The Little Feet Dance Association is a performing arts program in an urban area. It was established to increase appreciation for dance among youth and strengthen social bonds in the community. The association has been in existence for several years, and it has recently attracted the attention of several governmental, foundation, and private donors who support its cause. Prior to making a financial commitment, however, these funders have asked for documentation that the association is effective in accomplishing its goals. As a managerial accountant on the board of the Little Feet Dance Association, you have been asked to assist in responding to the funders’ request.
Required
a. Prepare a graphic or chart showing possible outputs and outcomes that could be expected from activities and expenditures of a not for profit organization such as Little Feet Dance Association.
b. List two indicators that could be used to measure whether the association met each of its intermediate and end outcomes.
c. What questions do you anticipate potential funders will have when reviewing the outcomes sequence chart and indicators that the association has put together?
1. A term used to indicate that a not for profit organization is communicating directly with a public official in either the executive or legislative branch of the state government for the purpose of influencing legislation is:
a. Influencing.
b. Grass roots lobbying.
c. Direct lobbying.
d. Propagandizing.
2. A not for profit organization that is exempt from federal income taxes under IRC Sec. 501(c)(3), exists to make grants to public charities, and receives its support from a small number of individuals or corporations and investment income rather than from the public at large is called a:
Public Charity. The Kids Club of Clare County is a public charity under IRC Sec. 501(c)(3). It had total support last year of the following:
United Way support
$ 80,000
Grant from Clare County
70,000
Contributions
350,000
Investment income
75,000
$575,000
Of the $350,000 received from contributors, $250,000 came from five contributors, each of whom gave more than $5,000; the other $100,000 came from small individual contributors.
Required
a. Calculate the total amount of support that qualifies as “public support” in meeting the external support test to escape private foundation status.
b. Is the organization considered a public charity or a private foundation? Why?
c. If the organization had received an additional $140,000 grant from one individual during the year, would the NPO still be classified the same as in your response to part b (assuming that the previous five gifts still represent more than 1 percent of the new total)?
Unrelated Business Income Tax. The Silverton Symphony Orchestra Hall is a well established not for profit organization exempt under IRC Sec. 501(c)(3) that owns a facility that is home to the local symphony orchestra. Its mission is to increase access to the arts for the community of Silverton. The facility is used throughout the year for many activities. Which of the following regularly conducted activities of Silverton Symphony Hall are subject to unrelated business income tax?
1. Sale of Silverton Symphony Orchestra Concert CDs in the facility’s gift shop.
2. Rental of the facility to the high school drama club.
3. Rental of two apartments in the facility to the symphony.
4. Sale of the season ticket membership list to a local music store.
5. Rental of the facility to the state CPA association for continuing professional education events.
6. Internet sales of gift shop items with the Silverton Symphony Orchestra logo.
7. Lease of the facility’s parking lot to the local university on football game days.
Mandalay Resort Group owns and operates casinos at several of its hotels, located primarily in Nevada. At the end of one fiscal year, the following accounts and notes receivable were reported (in thousands):
Hotel accounts and notes receivable
$31,724
Less: Allowance for doubtful accounts
1,699
$30,025
Casino accounts receivable
$44,139
Less: Allowance for doubtful accounts
12,300
31,839
a. Compute the percentage of the allowance for doubtful accounts to the gross hotel accounts and notes receivable for the end of the fiscal year.
b. Compute the percentage of the allowance for doubtful accounts to the gross casino accounts receivable for the end of the fiscal year.
c. Discuss possible reasons for the difference in the two ratios computed in (a) and (b).
Journalize the following transactions in the accounts of Simmons Co., a medical equipment company that uses the direct write off method of accounting for uncollectible receivables:
Feb. 10.
Sold merchandise on account to Dr. Pete Baker, $21,400. The cost of the merchandise sold was $12,600.
July 9.
Received $13,000 from Dr. Pete Baker and wrote off the remainder owed on the sale of February 10 as uncollectible.
Oct. 27.
Reinstated the account of Dr. Pete Baker that had been written off on July 9 and received $8,400 cash in full payment.
At the end of the current year, the accounts receivable account has a debit balance of $650,000, and net sales for the year total $5,500,000. Determine the amount of the adjusting entry to provide for doubtful accounts under each of the following assumptions:
a. The allowance account before adjustment has a credit balance of $3,175. Bad debt expense is estimated at 1⁄4 of 1% of net sales.
b. The allowance account before adjustment has a credit balance of $4,600. An aging of the accounts in the customer ledger indicates estimated doubtful accounts of $17,500.
c. The allowance account before adjustment has a debit balance of $8,100. Bad debt expense is estimated at 1⁄2 of 1% of net sales.
d. The allowance account before adjustment has a debit balance of $8,100. An aging of the accounts in the customer ledger indicates estimated doubtful accounts of $24,650.
Chuck’s Auto Supply distributes new and used automobile parts to local dealers throughout the Southeast. Chuck’s credit terms are n/30. As of the end of business on July 31, the following accounts receivable were past due:
Account
Due Date
Amount
Ben’s Pickup Shop
June 9
$5,000
Bumper Auto
July 10
4,500
Downtown Repair
March 18
2,000
Jake’s Auto Repair
May 19
1,800
Like New
June 18
750
Sally’s
April 12
2,800
Uptown Auto
May 8
1,500
Yellowstone Repair & Tow
April 15
3,100
Determine the number of days each account is past due.
The accounts receivable clerk for Vandalay Industries prepared the following partially completed aging of receivables schedule as of the end of business on November
Not
Days Past Due
Past
Over
Customer
Balance
Due
1–30
31–60
61–90
90
1
Aaron Brothers Inc.
2,000
2,000
1
2
Abell Company
1,500
1,500
2
21
Zollo Company
5,000
5,000
21
22
Subtotals
772,500
440,000
180,000
78,500
42,300
31,700
22
The following accounts were unintentionally omitted from the aging schedule and not included in the subtotals above:
Customer
Balance
Due Date
Tamika Industries
$25,000
August 24
Ruppert Company
8,500
September 3
Welborne Inc.
35,000
October 17
Kristi Company
6,500
November 5
Simrill Company
12,000
December 3
a. Determine the number of days past due for each of the preceding accounts.
b. Complete the aging of receivables schedule by including the omitted accounts.
Assume that the allowance for doubtful accounts for Vandalay Industries has a credit balance of $6,150 before adjustment on November 30. Journalize the adjusting entry for uncollectible accounts as of November 30.
Not
Days Past Due
Past
Over
Customer
Balance
Due
1–30
31–60
61–90
90
1
Aaron Brothers Inc.
2,000
2,000
1
2
Abell Company
1,500
1,500
2
21
Zollo Company
5,000
5,000
21
22
Subtotals
772,500
440,000
180,000
78,500
42,300
31,700
22
The following accounts were unintentionally omitted from the aging schedule and not included in the subtotals above:
Renegade Co. is a wholesaler of motorcycle supplies. An aging of the company’s accounts receivable on December 31, 2008, and a historical analysis of the percentage of uncollectible accounts in each age category are as follows:
Percent
Age Interval
Balance
Uncollectible
Not past due
$400,000
1%
1–30 days past due
80,000
2
31–60 days past due
18,000
5
61–90 days past due
12,500
10
91–180 days past due
6,000
70
Over 180 days past due
2,500
90
$519,000
Estimate what the proper balance of the allowance for doubtful accounts should be as of December 31, 2008.
Assume that the allowance for doubtful accounts for Renegade Co. had a debit balance of $3,500 as of December 31, 2008. Journalize the adjusting entry for uncollectible accounts as of December 31, 2008.
The following selected transactions were taken from the records of Kemper Company for the year ending December 31, 2008:
Feb. 2.
Wrote off account of L. Armstrong, $7,250.
May 10.
Received $4,150 as partial payment on the $8,500 account of Jill Knapp. Wrote
off the remaining balance as uncollectible.
Aug. 12.
Received the $7,250 from L. Armstrong, which had been written off on February
2. Reinstated the account and recorded the cash receipt.
Sept. 27.
Wrote off the following accounts as uncollectible (record as one journal entry):
Kim Whalen
$4,400
Brad Johnson
2,210
Angelina Quan
1,375
Tammy Newsome
2,850
Donna Short
1,690
Dec. 31.
The company prepared the following aging schedule for its accounts receivable:
Aging Class (Number
Receivables Balance
Estimated Percent of
of Days Past Due)
on December 31
Uncollectible Accounts
0–30 days
$160,000
3%
31–60 days
40,000
10
61–90 days
18,000
20
91–120 days
11,000
40
More than 120 days
6,500
75
Total receivables
$235,500
a. Journalize the transactions for 2008 under the direct write off method.
b. Journalize the transactions for 2008 under the allowance method, assuming that the allowance account had a beginning balance of $18,000 on January 1, 2008, and the company uses the analysis of receivables method.
c. How much higher (lower) would Kemper’s 2008 net income have been under the direct write off method than under the allowance method?
During its first year of operations, West Plumbing Supply Co. had net sales of $1,800,000, wrote off $51,000 of accounts as uncollectible using the direct write off method, and reported net income of $125,000. Assume that during the second year of operations West Plumbing Supply Co. had net sales of $2,200,000, wrote off $61,500 of accounts as uncollectible using the direct write off method, and reported net income of $143,500.
a. Determine what net income would have been in the second year if the allowance method (using 3% of net sales) had been used in both the first and second years.
b. Determine what the balance of the allowance for doubtful accounts would have been at the end of the second year if the allowance method had been used in both the first and second years.
Becker Company wrote off the following accounts receivable as uncollectible for the first year of its operations ending December 31, 2008:
Customer
Amount
Skip Simon
$20,000
Clarence Watson
13,500
Bill Jacks
7,300
Matt Putnam
4,200
Total
$45,000
a. Journalize the write offs for 2008 under the direct write off method.
b. Journalize the write offs for 2008 under the allowance method. Also, journalize the adjusting entry for uncollectible accounts. The company recorded $2,000,000 of credit sales during 2008. Based on past history and industry averages, 3% of credit sales are expected to be uncollectible.
c. How much higher (lower) would Becker Company’s 2008 net income have been under the direct write off method than under the allowance method?
GAO Independence Standards. Indicate which of the following activities performed by an auditor for a governmental client are (a) allowable, (b) permitted if safeguards are in place, or (c) prohibited.
1. Serving as an adviser on the building subcommittee for the county.
2. Preparing a $4,000,000 indirect cost proposal.
3. Providing all payroll services for the client.
4. Converting the financial records from the cash basis to GAAP basis.
5. Providing advice on setting up the chart of accounts in a commercially purchased software package.
6. Maintaining the depreciation schedules for which management has determined the useful lives and residual values.
7. Providing appraisals and valuation of property held by the government.
8. Assessing program outcomes for three government programs.
9. Providing internal audit services.
10. Preparing draft financial statements from the client’s adjusted trial balance.
Unqualified Audit Report. Following is the unqualified audit report for the City of Sand Key.
The Honorable Mayor
Members of the City Commission and
City Manager
City of Sand Key
We have audited the accompanying financial statements of the City of Sand Key (the City) as of and for the year ended September 30, 2011. These financial statements are the responsibility of the City’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards and the standards applicable to financial audits contained in the Government Audit Standards, issued by the Comptroller General of the United States. Those standards require that we plan and perform the audit to obtain a reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the City as of September 30, 2011, and the respective changes in financial position thereof for the year then ended in conformity with accounting principles generally accepted in the United States of America.
Our audit was conducted for the purpose of forming an opinion on the financial statements taken as a whole. The information presented in the Statistical Section is presented for the purpose of additional analysis and is not a required part of the basic financial statements.
Such information has not been subjected to the auditing procedures applied in the audit of the basic financial statements and, accordingly, we express no opinion on it.
Steele and Steele, P.A.
January 12, 2012
Required
Based on your knowledge of audit reporting requirements for government audits, you have determined that the audit report issued by Steele and Steele does not meet requirements. Provide a list of changes that would need to be made to the audit report to bring it into conformance with audit report requirements.
Budgeting Process and Policies. The City of Topeka, Kansas, has received a Distinguished Budget Presentation Award for at least 12 years. An excerpt from the 2008 Budget is presented on the next page:
Financial Policies, Guidelines, and Practices Budgeting, Accounting, and Audit Practices. Kansas law prescribes the policies and procedures by which the cities prepare annual budgets. By August 25th of each year, prior to commencement of the new fiscal year on the following January 1st, the governing body of the City must adopt a budget, which is filed with the City Clerk and the State Director of Accounts and Reports. The budget itemizes anticipated revenues and proposed expenditures, detailed by program and object of expenditures, for the next fiscal year. Funds must be balanced so that total resources equal obligations in accordance with Kansas law (K.S.A. 79 2927), which requires that, “The budget of expenditures for each fund shall balance with the budget of revenues for such fund. . . .” The level of budgetary control or expenditure limit is at the fund level, except for the General Fund, which also has established expenditure limits for each Department financed. However, statutes allow for the transfer of budgeted amounts between line items within a fund. Departments are responsible for managing their budgets to the fund or department total level. Changes from expenditure category to expenditure category may be made administratively. Transfers of $15,000 or more from department to department within the General Fund may only be made with the approval of the City Council. The City maintains a financial and budgetary control system. Expenditures and revenues are tracked to ensure adherence to the budget and awareness of the financial environment. Monthly reports are prepared that compare actual revenues and expenditures to budgeted amounts and provide a picture of the City’s cash position. Kansas statutes require that the budget be prepared for the next fiscal year by August 1st of each year. The proposed budget must then be published along with a notice of public hearing on or before August 5th. The public hearing is held by August 15th, but must be at least ten days after publication. The budget is to be adopted on or before August 25th. The statutes allow for the governing body to increase the originally adopted budget if that increase is financed with previously unbudgeted revenue other than ad valorem property taxes. A notice of public hearing to amend the budget must be published in the local newspaper. At least ten days after publication, the hearing may be held and the City Council may amend the budget. In order to ensure that Kansas municipalities conduct their affairs in a fiscally responsible manner, the State Legislature enacted a cash basis law in 1933 (K.S.A. 10 1101 et seq.) which states in part that it is unlawful, except where bonds, temporary notes, or no fund warrants are authorized, “for the governing body of any municipality to create any indebtedness in excess of the amount of funds actually on hand in the treasury of such municipality, or to authorize the issuance of any order, warrant or check, or other evidence of such indebtedness of such municipality in excess of the amount of funds actually on hand in the treasury of such municipality at the time for such purpose.” The purpose of the cash basis law is to prevent municipalities from spending more than they receive annually in operating revenues, and to prevent the issuance of short term debt to cover operating expenditures. Kansas statutes and regulations of the Kansas Board of Accountancy provide for municipal accounting in conformance with generally accepted accounting principles (GAAP). Separate funds are maintained by the City for specific purposes and projects, in compliance with GAAP, State laws and regulations, bond covenants, tax levies, grant agreements, and City ordinances and resolutions. The City prepares a Comprehensive Annual Financial Report (CAFR), disclosing the financial position, results of operations, and changes in fund equities or retained earnings for all funds and accounts groups in accordance with GAAP. An independent firm of certified public accountants performs annual audits of this information. The audited CAFR is filed in the Office of the City Clerk and with the Nationally Recognized Municipal Securities Information Repositories (NRMSIRs), among other agencies.
Required
a. Evaluate whether this passage from the budget could be clearly understood by the average reader.
b. What changes can you recommend in the content or presentation of this section on budgeting, accounting, and audit practices that the city’s financial managers may consider to improve the usefulness of this section for members of the city council? For citizens?
Indirect Costs. As a cost reimbursement accountant in a large public research university, you are aware that federal agencies have increased auditing efforts in the area of federal research grants to higher education institutions. In particular, OMB Circular A–21 detailing allowable costs for colleges and universities receiving federal funds. The administration has asked you whether it is appropriate to include certain overhead costs in the pool of indirect costs (facilities and administrative costs) that are recovered in most federal research awards. Items include (1) holiday lights put on the president’s university owned home, (2) library books in the research section of the undergraduate library, (3) the cost of a large boat used by higher administration in meeting with faculty and outside researchers for social events, (4) advertising new graduate programs in the large urban newspaper, (5) clerical salaries in the academic departments where a large amount of research is conducted, and (6) utility bills in the research wing of one of the buildings.
Required
Write a short professional memo to the administration giving your opinion about whether these costs would be allowable “indirect costs” to be recovered in part by federal research grants. Defend your position.
Examine the Budget. Obtain a copy of a recent operating budget document of a government.* Familiarize yourself with the organization of the operating budget document; read the letter of transmittal or any narrative that accompanies the budget. Budgetary practices may differ from the GAAP reporting model as to basis, timing, perspective, and entity. GASB standards (Codification, Section 2400.
110–199) define these differences as:
1. Basis differences arising through the employment of a basis of accounting for budgetary purposes that differs from the basis of accounting applicable to the fund type when reporting on the operations in accordance with GAAP.
2. Timing differences that can result in significant variances between budgetary practices and GAAP may include continuing appropriations, project appropriations, automatic appropriations, and biennial budgeting.
3. Perspective differences resulting from the structure of financial information for budgetary purposes. The perspectives used for budgetary purposes include fund structure and organizational or program structure. In addition, some subsidiary perspective, such as nature of revenue source, special projects, or capital and operating budgets, may also be used. The fund structure and individual fund definitions establish which assets, liabilities, equities, and revenue and expenditure/expense flows are recorded in a fund. In the traditional view, budgeting, accounting, financial reporting, and auditing would follow the fund perspective.
4. Entity differences occur when “appropriated budget” either includes or excludes organizations, programs, activities, and functions that may or may not be compatible with the criteria defining the governmental reporting entity.
Required
Answer the following questions, which aid in assessing the quality of the budget document you are reviewing.†
Policy Document. Does the operating budget you are reviewing include a coherent statement of entity wide long term financial policies and nonfinancial goals and objectives? Does the budget document describe the entity’s short term initiatives that guide budget development for the upcoming year? Does the budget document include a coherent statement of goals and objectives of organizational units? Does the document include a budget message that articulates priorities and issues for the budget for the new year? Does the message describe significant changes in priorities from the current year and the factors that led to those changes?
Financial Plan. Does the budget document describe all funds that are subject to appropriation? Does the document present a summary of major revenues and expenditures as well as other financing sources and uses? Does the document include summaries of revenues, other financing sources, and expenditures and other financing uses for prior year actual, current year budget and/or estimated current year actual, and proposed budget year? Are major revenue sources described? Are the underlying assumptions for revenue estimates and significant revenue trends explained? Does the document include projected changes in fund balances for governmental funds included in the budget presentation, including all balances potentially available for appropriation?
Does the budget document include budgeted capital expenditures (even if these are authorized in a separate capital budget)? Does the document describe whether, and to what extent, significant and nonroutine capital expenditures or other major capital spending will impact the entity’s current and future operating budget? Are financial data on current debt obligations provided, describing the relationship between current debt levels and legal debt limits, and explaining the effects of existing debt levels on current and future operations? Is the basis of budgeting explained for all funds, whether cash, modified accrual, or some other statutory basis?
Operations Guide. Does the operating budget document describe activities, services, or functions carried out by organizational units? Are objective measures of progress toward accomplishing the government’s mission, as well as goals and objectives, provided for specific units or programs? Does the budget document include an organizational chart for the entire organization? Is a schedule(s) or summary table provided giving personnel or position counts for prior, current, and budget years?
†These questions are paraphrased from the awards criteria established by the Government Finance Officers Association for its Distinguished Budget Presentation Awards Program.
Communication Device. Does the budget document provide summary information, including an overview of significant budgetary issues, trends, and resource choices? Does the budget document explain the effect, if any, of other planning processes (e.g., strategic plans, long range financial plans, capital improvement plans) on the budget and budget process? Is the process used to prepare, review, adopt, and amend the budget explained? Are charts and graphs used, where appropriate, to highlight financial and statistical information? Is narrative information provided when the messages conveyed by the charts and graphs are not self evident? Does the document provide narrative, tables, schedules, or matrices to show the relationship between functional units, major funds, and nonmajor funds in the aggregate? Is a table of contents provided tomake it easy to locate information in the document? Is there a glossary to define terms (including abbreviations and acronyms) that are not readily understood by a reasonably informed lay reader? Does the document include statistical and supplemental data that describe the organization and the community or population it serves and provide other pertinent background information related to services provided? Finally, is the document produced and formatted in such a way as to enhance understanding by the average reader? Is it attractive, consistent, and oriented to the reader’s needs?
Police Department Budget. The police chief of the Town of Meridian submitted the following budget request for the police department for the forthcoming budget year 2011–12.
Actual
Budget
Forecast
Budget
Item
FY 2010
FY 2011
FY 2011
FY 2012
Personnel
$1,051,938
$1,098,245
$1,112,601
$1,182,175
Supplies
44,442
61,971
60,643
64,450
Maintenance
47,163
45,310
46,139
47,422
Miscellaneous
34,213
36,272
32,198
37,723
Capital outlay
65,788
69,433
67,371
102,210
Totals
$1,243,544
$1,311,231
$1,318,952
$1,433,980
Upon questioning by the newly appointed town manager, a recent masters graduate with a degree in public administration from a nearby university, the police chief explained that he had determined the amounts in the budget request by multiplying the prior year’s budget amount by 1.04 (to allow for the expected inflation rate of 4 percent). In addition, the personnel category includes a request for a new uniformed officer at an estimated $40,000 for salary, payroll expenses, and fringe benefits. Capital outlay includes a request for a new patrol vehicle at an estimated cost of $30,000. The amount of $300 was added to the maintenance category for estimated maintenance on the new vehicle. The police chief is strongly resisting instructions from the town manager that he justify the need not only for the new uniformed position and additional vehicle but also for the existing level of resources in each category. The town manager has stated she will not request any increase in the police department’s budget unless adequate justification is provided.
Required
a. Evaluate the strengths and weaknesses of the police chief’s argument that his budget request is reasonable.
b. Are the town manager’s instructions reasonable? Explain.
c. Would the town council likely support the town manager or the police chief in this dispute, assuming the police chief might take his case directly to the town council?
d. What other improvements could be made to the town’s budgeting procedures?
Budgeting Cash Flows. Eagleview City prepares a quarterly forecast of cash flows for its water service department. Data for the upcoming quarter (in alphabetical order) measured on the cash basis are presented below.
Bond interest expense
$ 1,950,000
Current month’s collections on receivables
4,349,350
Interest income on excess cash from previous months
1,849
Investment income
11,250
Materials and supplies disbursements
925,000
Non operating revenue
479,030
Other fees and services disbursements
4,070,000
Previous months’ collections on receivables
4,582,425
Personal services disbursements
1,991,000
Transfers in
50,000
Transfers out
540,000
The city maintains no more than the minimum cash balance of $100,000 on hand.
Required
a. What are the projected cash flows from operating activities, noncapital financing activities, capital and related financing activities, and investing activities?
Indicate whether the balance is a positive cash flow or a negative cash flow.
b. What is the projected amount the city will have to borrow at the end of the quarter to maintain the minimum balance, or what is the amount the city has to invest that exceeds the minimum balance?
c. What steps can the city take to prevent being in a position where it will have to borrow at the end of the quarter?
This problem is adapted from an example in William R. Voorhees and Jeongwoo Kim, “Cash Flow Forecasting: Principles,” Encyclopedia of Public Administration and Public Policy, Taylor & Francis, 2008, pp. 285–290.
SEA Reporting. The City of Ankeny, Iowa, has produced a Service Efforts and Accomplishments report since 2003 in an attempt to answer the question, “Am I getting my money’s worth?” for its citizens. The city received the Association of Governmental Accountants Certificate of Excellence in Service Efforts & Accomplishments Reporting for 2005 and 2006. Reproduced below is an excerpt from the Fall 2006–07 SEA report that details Library Services.
New in the 2006–07 report is library programming and participation. This measure shows the efforts of library staff to offer more library programs to the increasing population and customer base in the city. As shown in the graph, program participation has seen steady increases over the past four years, with some programs so high in demand waiting lists to participate are starting to occur.
Citizen Perceptions
The 2005 Community survey reported that 84 percent of city residents rated Library services as “good” or “excellent,” only marginally down from 86 percent in 2003. For the variety of materials at the library, 79 percent of citizens rated the variety as “good” or “excellent,” unchanged from 2003.
Library Budget
The owner of a house with a total assessed valuation of $150,000 paid property taxes of $33 in FY 2007 to support the Library. Twenty six percent (26%) of the Library’s FY 2007 budget depends upon support from Polk County in return for services provided to rural Polk County residents. Polk County’s support is expected to decrease after FY 2007. Options being considered to offset the loss of county funding include allocation of General Fund monies and/or reduction in library services.
Library
2003–04
2004–05
2005–06
2006–07
Performance Measures
Actual
Actual
Actual
Actual
Authorized FT Positions
7
7
7
7
Total Visitations
296,441
299,405
302,399
317,518
City Resident Cardholders
19,805
23,161
25,607
25,318
Non Resident Cardholders
6,761
6,114
6,655
6,559
Average Visits per Cardholder
11
10
9
10
Number of Circulations
316,117
320,910
350,213
367,723
Number of Items for Circulation
75,411
78,697
82,955
86,273
Number of Reference Desk Inquiries
21,949
25,266
26,051
27,353
Number of PC Users
32,250
39,400
41,704
58,815
Number of PC Users per Available PC
1,194
1,359
1,438
1,837
Number of Special Programs
475
629
856
955
Number of Participants per Program
25
30
24
24
Cost per Registered Borrower
$35
$34
$ 32
$ 33
Cost per Circulation
$2.96
$3.09
$2.91
$2.85
Cost per Visitation
$3.16
$3.32
$3.37
$3.31
Required
a. Which of the performance measures best represents inputs, outputs, and outcomes?
b. How does the city demonstrate efficiency with respect to the General Fund budget it receives?
c. How would you address a citizen who feels he or she is not getting his or her money’s worth?
Activity based Costing in a Government. The midsize City of Orangeville funds an animal control program intended to minimize the danger stray dogs pose to people and property. The program is under scrutiny because of current budgetary constraints and constituency pressure. An animal control warden responds to each complaint made by citizens about dogs running loose. Approximately one in six complaints results in the capture of a dog. When a dog is caught, the warden must drive it to a kennel 20 miles from the center of the city. Donna’s Kennels, a privately owned animal boarding establishment, is under contract with the city to board, feed, and care for the impounded dogs. It is a no kill shelter (i.e., it does not euthanize healthy animals), and dogs remain there until they are claimed by their owners or adopted. The program’s complaint and impoundment data for the past four years follow:
Year 1
Year 2
Year 3
Year 4
Complaints
2,330
2,410
2,540
2,730
Impoundments
376
398
414
440
Impoundment rate
16.1%
16.5%
16.3%
16.1%
Costs of Orangeville’s animal control program are as follows. The city employs two animal control wardens, a clerk, and a program director. The task of the wardens is to respond to complaints, drive to the site, search for the dog, and deliver it (if it is found) to Donna’s Kennels. The clerk is responsible for issuing licenses to dogs that are returned to their owners or are adopted, as well as tracking correspondence between Donna’s Kennels and the city. The clerk also tracks program statistics and provides support to the program director. The city owns and operates two vehicles specially designed for impounding and transporting stray dogs. For $10 per dog per day, Donna’s Kennels provides shelter, food, and routine veterinary care. On average, 60 percent of impounded dogs are returned to their owners in seven days. The other 40 percent stay at Donna’s Kennels for an average of 14 days before being adopted. Summarized program costs follow:
Salaries (annual):
Program director
$40,000
Animal wardens (2)
$56,000 ($28,000 _ 2)
Clerk
$27,000
Vehicles:
Cost
$48,000 ($24,000 _ 2)
Expected life
7 years
Operating costs
$0.30 per mile
Dog care:
Shelter, food, medical care
$10 per dog per day
(according to the contract)
Revenues:
Fees received for adoptions
$35 per adoption
Fees received from owners:
Fines
$75 per dog
Boarding expense reimbursement
$10 per dog per day
Critics of the animal control program argue that it costs too much to drive to the distant kennel to deliver an impounded dog. They have suggested that the city convert a vacant building within the city limits into an animal shelter to save on transportation costs. Prompted by the need to cut the city budget and address the public outcry, city officials are reviewing the budget proposal for the animal control program and are looking for ways to reduce the program’s costs.
Required
a. Prepare a diagram that identifies (1) the activities related to the animal control program, (2) the relationship among each of the activities, (3) the resources required for each activity, and (4) the cost drivers for each activity. Use the format of Illustration 13–9.
b. Calculate the cost of each activity. Show your work. Use the format of Illustration 13–10.
c. Interpret the results of the activity based costing example. This problem is taken from the International City/County Management Association Service Report:
Introduction to Activity Based Costing, February 1998, pp. 9–13.
Total Program Costs. On the basis of the following data, prepare a statement for the Town of Chippewa for the year ended June 30, 2011, showing the total cost of solid waste removal and the cost per ton of residential solid waste removed or cubic yard of commercial solid waste removed (carry unit costs to three decimal places).
Residential
Commercial
By town employees:
Salaries and wages
$702,000
$481,000
Materials and supplies
$ 39,000
$ 36,090
Equipment use
$300,840
$201,470
Tons collected
165,000
—
Cubic yards collected
—
248,000
Labor hours
90,000
68,000
By contractors:
Cost
$ 78,900
$ 48,000
Tons collected
23,000
—
Cubic yards collected
—
30,000
Overhead for town collection of residential solid waste is $0.948 per labor hour; for commercial solid waste collection it is $0.924 per labor hour. Overhead for contract residential solid waste collection is 20 percent of cost (exclusive of overhead); for commercial solid waste collection it is 15 percent of cost (exclusive of overhead).
Temporarily Restricted Net Assets. For several years, Baytown Rehabilitative Camp for Disabled Children (hereafter referred to as the camp) has applied for an operating grant from the Baytown Area United Way. As the finance adviser for the local United Way allocation panel, it is your responsibility to evaluate the camp’s budget request for the forthcoming year and its audited financial statements. The camp’s most recent comparative statement of financial position and statement of activities are presented below.
BAYTOWN REHABILITATIVE CAMP FOR DISABLED CHILDREN
Statement of Financial Position
December 31, 2011, and 2010
Assets
2011
2010
Current assets
Cash
$ 36,802
$ 12,248
Contributions receivable
28,728
16,372
Prepaid expenses
15,559
17,748
Total current assets
81,089
46,368
Investments—Temporarily restricted
90,434
122,368
Property, plant, and equipment
Land
175,000
175,000
Buildings and building improvements (net of accumulated
depreciation of $137,440 and $130,200)
449,768
457,008
Equipment (net of accumulated depreciation
of $195,370 and $186,788)
185,342
171,924
Total property, plant, and equipment
810,110
803,932
Total assets
$981,633
$972,668
Liabilities and Net Assets
Current liabilities
Accounts payable
$ 23,852
$ 35,722
Accrued payroll and other accrued liabilities
5,289
5,064
Total current liabilities
29,141
40,786
Net assets
Unrestricted
862,058
809,514
Temporarily restricted
90,434
122,368
Total net assets
952,492
931,882
Total liabilities and net assets
$981,633
$972,668
BAYTOWN REHABILITATIVE CAMP FOR DISABLED CHILDREN
Statement of Activities
For the Year Ended December 31, 2011
Unrestricted
Temporarily Restricted
Total
Revenues and other support
Contributions
$ 65,250
$ 20,000
$ 85,250
United Way allocation
25,000
25,000
Charges to clients
34,400
34,400
Donated goods and services
105,160
105,160
Interest
154
5,566
5,720
Miscellaneous
4,012
4,012
Net assets released from restriction satisfaction of purpose
57,500
(57,500)
-0-
Total revenues and other support
291,476
(31,934)
259,542
Expenses
Program services
152,828
152,828
Management and general
77,604
77,604
Fund-raising
8,500
8,500
Total expenses
238,932
238,932 20,610
Increase (decrease) in net assets
52,544
(31,934)
Net assets, December 31, 2010
809,514
122,368
931,882
Net assets, December 31, 2011
$862,058
$ 90,434
$952,492
Additional Information: As reflected in the camp’s 2011 statement of activities, the United Way agency allocated $25,000 to the camp for fiscal year 2011. However, the amount allocated was $5,000 less than the camp had requested in its fiscal year 2011 budget, reflecting the allocation panel’s concern about the camp’s inadequate financial reserves and low ratio of program services expense to total expense (only 57 percent in 2010). As a condition for receiving the $25,000 fiscal year 2011 allocation, Baytown Rehabilitative Camp agreed to take actions to improve its financial reserves and its ratio of program services expense to total expense, including an increase in its fund-raising efforts and a reduction in its support payroll. Another area of concern to the allocation panel has been the camp’s long delay in using a restricted contribution of $100,000 received several years earlier. This gift was restricted by the donor for future expansion of a building used as a dining hall and for rehabilitative activities. This contribution has been invested in CDs and has grown to $122,368 as of December 31, 2010. The camp is requesting a $35,000 United Way allocation for fiscal year 2012, based on a growing demand for its services and improvement made in its financial condition. As financial adviser for the local United Way allocation panel, however, you note that much of the improvement in unrestricted net assets resulted from $37,500 of temporarily restricted net assets that were released from restriction during fiscal year 2011, with no corresponding increase in the balance of the Buildings and Building Improvements account. (Note: $20,000 of the $57,500 released from restriction related to $20,000 of temporarily restricted contributions received during 2011.) You immediately contact the camp administrator for an explanation, whereupon she explains that the board of directors voted to use $37,500 of previously restricted investments for operating purposes after the administrator reported to the board that the original agreement with the donor could not be located and the donor was now deceased. She further indicated that the board may continue to use this pool of resources to further improve the camp’s financial condition.
Required
a. As financial adviser, evaluate the camp’s statement of financial position and statement of activities and prepare a report for the chair of the allocation committee indicating the extent to which the camp’s financial situation has improved or worsened. You should base your recommendation on measures such as the current ratio and ratio of unrestricted net assets, net of total property, plant, and equipment, to total expenses for the year. In your analysis you should look at the camp’s unrestricted financial position, both including and excluding the questionable use of the $37,500 of restricted net assets for operating purposes.
b. Has the camp’s board of directors violated the terms of the $100,000 contribution that was restricted by the donor for future building expansion? What sanctions might be taken against the board and the camp administrator for not meeting their fiduciary responsibilities?
c. What amount of United Way funds would you recommend be allocated to the camp for fiscal year 2012? Explain your recommendation.
Terms of Gift. The Shelter Association of Jefferson County receives the majority of its funding from the local chapter of the United Way. That federated fund raising organization has a policy that if a member agency reports unrestricted net assets in excess of one year’s budgeted revenues and support, the excess will be deducted from its allocation for next year. The association’s reporting year ends December 31, and unrestricted net assets are just about equal to last year’s revenues and support. On December 30, a potential donor contacts the Shelter Association about making a large contribution. It is important to him to make the gift in the current calendar year so that he can deduct the charitable contribution on his personal federal income tax return. However, he has heard that the treasurer of the association and several board members recently resigned after allegations of financial mismanagement were made. He is considering restricting his gift for the direct purposes of acquiring food, clothing, and supplies for the homeless over the next several years so that management could use none of the money for overhead expenses.
Required
Take the position of the association’s certified public accountant.
a. Do you recommend that the association advise the potential donor to make the gift unrestricted or restricted? Give your reasons.
b. The potential donor asks you how he can be sure that the association will spend his contribution as he intends, assuming that he restricts the purpose of his gift. Explain to him what kind of public information is available. Do you consider that information adequate to assess whether the not for profit agency is efficient and effective in its use of public donations?
Institutionally Related Foundations. Compass State University Foundation (CSUF) was incorporated as a not for profit organization to support a public university in its fund raising efforts and the management of its endowment. The foundation has a self perpetuating board, one third of whose members are selected by the university’s president. Under a joint operating agreement, the university agrees to provide staff, computers, mail service, and office space to the foundation and to pay the foundation a management fee based on a formula that incorporates a percentage of the endowment balance, cash gifts received, dollars raised, and donor records maintained. In addition, the university transferred its $8 million endowment to the foundation to manage. Since the inception of the foundation, the endowment has grown to $30 million.
Required
a. From an accounting (not legal) point of view, is the foundation a separate entity or a component unit of the related public university? What guidance is provided in GASB Codification Sec. 2100, to address this financial reporting issue?
b. Who are the stakeholders in the foundation and what are their accountability concerns?
c. Assume the role of the president of the university and discuss the advantages and disadvantages of transferring $8 million of the university’s endowment funds to the foundation. This case is based on S. Ravenscroft and S. Kattelus, “Compass State University: Managerial Accounting Issues in a Nonprofit Entity,” Issues in Accounting Education 13, no. 3 (1998).
The Maryville Cultural Center recently conducted a successful talent show in which local talent performed for a nominal prize. The talent show is an ongoing major event and is central to the center’s mission. The event raised $4,800 in gross revenue. Expenses related to the event included $1,000 to rent an auditorium, $1,200 to advertise the event, $500 for trophies and other awards for the winner and the runners up, and $100 for printing and mailing tickets. The center believes there was no monetary value received by donors (attendees). To report this event in its statement of activities, the center will report:
a. Special event revenue of $4,800 and special event expense of $1,500.
b. Special event revenue of $4,800 and fund raising expense of $1,300.
c. Special event revenue of $2,300 and fund raising expense of $1,300.
Classification of Revenues/Support and Expenses. For each of the independent transactions listed in the left hand column below, indicate which of the revenue/support or expense classifications apply by choosing one or more of the letters from the listed items in the right hand column. Choose all that apply.
Transaction
1. A museum gift shop sold prints of famous paintings.
2. An NPO incurred a cost for its annual financial statement audit.
3. A registered nurse volunteered 10 hours a week for a local agency for disabled persons.
4. A donor contributed $1 million to a not for profit hospital for a new clinic.
5. An art association hosted a $100 perplate dinner attended by members, donors, and potential donors.
6. A donor contributed securities valued at $10 million to be permanently invested. Earnings thereon are stipulated by the donor to be used for eye research.
7. An NPO job training center incurred payroll expenses of $500,000 for instructors and mechanics and $100,000 for the center director and clerical staff. Of this amount, $400,000 was spent from temporarily restricted federal and state grants.
8. The Older Adult Transportation Service received $8,000 from riders for the year and $52,000 from temporarily restricted grant sources.
Donated Services. Indicate whether each of the following donated services situations would require a journal entry for contribution revenue and a related expense or asset by circling Y for yes or N for no.
Y
N
1. Volunteers worked as sales assistants in a not for profit hospital snack shop.
Y
N
2. An architect provided pro bono design services for the planned remodeling of a local museum.
Y
N
3. A member of a church volunteered to repaint the church’s activities room to make it more attractive. Church leaders had not planned to repaint the room.
Y
N
4. Several local persons used their cars to deliver meals to senior citizens for Meals on Wheels.
Y
N
5. A psychiatrist volunteered several hours each week at a not for profit counseling center to assist persons with alcohol and drug addiction.
Y
N
6. A local CPA performed the regular annual financial statement audit for a local youth development camp, an NPO.
Y
N
7. A local church pastor donated several hours weekly to work with troubled youths in an after school activities program run by a local NPO.
Y
N
8. Helpful citizens served as “bell ringers” at the entrances of local businesses to collect money for the Salvation Army.
Joint Activities with a Fund Raising Appeal. Consider the following scenarios relating to activities that include a fund raising appeal:
1. The Green Group’s mission is to protect the environment by increasing the portion of waste recycled by the public. The group conducts a door to door canvass of communities that recycle a low portion of their waste. The canvassers share their knowledge about the environmental problems caused by not recycling with households, asking them to change their recycling habits. The canvassers also ask for charitable contributions to continue this work, although these canvassers have not participated in fund raising activities before.
2. Central University’s mission is to educate students in various academic pursuits. The political science department holds a special lecture series in which prominent world leaders speak about current events. Admission is priced at $250, which is above the $50 fair value of other lectures on campus, resulting in a $200 contribution. Invitations are sent to previous attendees and donors who have contributed significant amounts in the past.
3. The mission of Kid’s Camp is to provide summer camps for economically disadvantaged youths. It conducts a door to door solicitation campaign for its camp programs by sending volunteers to homes in upper class neighborhoods.
The volunteers explain the camp’s programs and distribute leaflets explaining the organization’s mission. Solicitors say, “Although your own children most likely are not eligible to attend this camp, we ask for your financial support so that children less fortunate can have this summer camp experience.”
Required
Determine for each scenario whether its purpose, audience, and content meet the criteria described in this chapter and Chapter 13 of the AICPA, Audit and Accounting Guide, Not For Profit Organizations so that the joint costs can be allocated between programs and support expenses. Explain your reasons.
Identify Departures from GAAP. The balance sheet and statement of activities for the Central Area Disadvantaged Youth Center for fiscal year 2011, prepared by a volunteer accountant with business experience, are presented on the following page.
CENTRAL AREA DISADVANTAGED YOUTH CENTER
Balance Sheet
As of December 31, 2011
Assets
Cash
$ 26,802
Investments
71,143
Contributions receivable
16,372
Supplies and other prepaid expenses
13,258
Land
70,000
Buildings (net of accumulated depreciation of $63,420)
249,750
Equipment (net of accumulated depreciation of $87,642)
184,230
Total assets
$631,555
Liabilities and net assets
Liabilities
Accounts payable
$ 25,722
Accrued liabilities
4,963
Total liabilities
30,685
Net assets
Invested in property, plant, and equipment
503,980
Other net assets
96,892
Total net assets
600,870
Total liabilities and net assets
$631,555
CENTRAL AREA DISADVANTAGED YOUTH CENTER
Statement of Activities
For Year Ended December 31, 2011
Revenues and contributions
Contributions from donors
$ 69,250
Grants:
From United Way
15,000
From state government
22,000
Contributed goods and services
43,500
Interest on investments
3,200
Miscellaneous—Sale of refurbished goods
6,900
Total revenues and contributions
159,850
Expenses
Payroll
62,580
Payroll taxes
4,605
Travel and conferences
2,795
Promotion and advertising
1,430
Cost of donated goods and services
32,600
Food, recreational, and other supplies
18,310
Postage, printing, and copying
1,057
Building and equipment maintenance
3,100
Utilities
4,378
Depreciation
12,700
Miscellaneous
10,380
Total expenses
153,935
Increase in net assets
5,915
Net assets, December 31, 2010
625,640
Net assets, December 31, 2011
$ 631,555
Required
a. Assume that you are the independent auditor performing a financial statement audit of the center. Identify and make a list of your concerns based on your review of the center’s financial statements. Would you feel comfortable issuing an unqualified (i.e., “clean”) opinion on the Central Area Disadvantaged Youth Center’s financial statements?
b. What actions would you require of the center’s management to address your concerns before you would be willing to perform this audit? What would be your recourse if the center refused to take the recommended actions?
Statement of Activities. The Atkins Museum recently hired a new controller. His experience with managerial accounting and strong communication skills were extremely attractive. The new controller sent each member of the Board of Trustees’ Finance Committee a set of the monthly financial statements one week before the monthly meeting for their review. The set included the following statement of activities.
THE ATKINS MUSEUM
Statement of Activities
For the Eleven Months Ended February 28, 2011
(in hundreds of dollars)
Public Exhibits
Abstract
Exhibit
Mgt. &
General
Total
Revenues:
Contributions
$ 61,400
$50,000
$ 0
$111,400
Charges for services
478,800
0
0
478,800
Interest income
0
0
2,500
2,500
Total revenues
540,200
50,000
2,500
592,700
Expenses:
Salaries and wages
381,900
24,700
44,200
450,800
Occupancy costs
38,100
12,000
14,900
65,000
Supplies
7,100
2,300
8,300
17,700
Equipment
5,000
0
6,500
11,500
Travel and development
2,800
0
6,900
9,700
Depreciation
12,000
1,500
6,300
19,800
Interest
0
0
3,700
3,700
Total variable expenses
456,900
40,500
90,800
588,200
Allocated management
and general expenses
85,300
5,500
(90,800)
0
Total costs Excess of revenues over expenses
542,200 $ (2,000)
46,000 $ 4,000
0 $ 2,500
588,200 $ 4,500
Other information: The management and general expenses are first allocated to the programs to which they directly relate; for example, the executive director’s salary is allocated to the Public Exhibit Program according to the percentage of time spent working on the program. Remaining unallocated management and general expenses are allocated to the programs as indirect costs based on the relative amount of salaries and wages to total salaries and wages for the programs.
Required
As a member of The Atkins Museum’s Board of Directors Finance Committee, review this statement and answer the following questions:
a. Is the statement in proper form according to SFAS No. 117?
b. What questions do you have for the controller?
c. The Atkins Museum would like to open an Impressionists exhibit. If its operating expenses are expected to be similar to that of the Abstract Exhibit, how much should the organization solicit in contributions or grants to cover the full cost of the program?
d. If you were a potential contributor to the Atkins Museum, do you think you have enough information from this statement on which to base your decision to donate?
Notes on Net Assets. The following items are taken from the financial statements of the Kids Clubs of America for the years ending December 31, 2011,
and 2010, with related notes.
KIDS CLUBS OF AMERICA
Statement of Financial Position (selected items)
For the Years Ended December 31, 2011 and 2010
2011
2010
Net assets:
Unrestricted
Undesignated
$ 878,901
$ 882,912
Board designated (Note 11)
66,540,051
57,479,525
Temporarily restricted (Note 9)
74,789,227
47,668,565
Permanently restricted (Note 9)
18,675,644
16,183,950
Total net assets
$160,883,823
$122,214,952
Required
a. Explain what the term board designated, unrestricted net assets mean. What does the board plan to do with these net assets? Can board members change their minds in future years?
b. Describe the types of restrictions that donors have placed on net assets. How much of those gifts are restricted for a period of time as opposed to purpose?
c. If an unexpected need arises, can the board of directors decide to spend donor restricted funds in ways other than the donor indicated when the contribution was made?
(Comprehensive OH variances) For 2010, Riguilio Inc. set predetermined variable and fixed overhead rates, respectively, of $6.50 and $9.35 based on an expected monthly capacity of 4,000 machine hours. Each unit of product requires 1.25 machine hours.
During August 2010, the company produced 3,360 units and incurred $27,000 of variable overhead costs and $41,400 of fixed overhead costs. The firm used 4,100 machine hours during August 2010.
a. Using separate overhead rates, calculate overhead variances using the four variance approach.
b. Using a combined overhead rate, calculate variances using the three variance approach.
c. Using a combined overhead rate, calculate variances using the two variance approach.
d. Using a combined overhead rate, calculate variances using the one variance approach.
(Comprehensive) Piedmont Manufacturing produces metal products with the following standard quantity and cost information:
Direct Material
Aluminum
4 sheets at $4
$ 16
Copper
3 sheets at $8
24
Direct labor
7 hours at $16
112
Variable overhead
5 machine hours at $6
30
Fixed overhead
5 machine hours at $4
20
Overhead rates were based on normal monthly capacity of 6,000 machine hours.
During November, the company produced only 850 units because of a labor strike, which occurred during union contract negotiations. After the dispute was settled, the company scheduled overtime to try to meet regular production levels. The following costs were incurred in November:
Material
Aluminum
4,000 sheets purchased at $3.80; used 3,500 sheets
Copper
3,000 sheets purchased at $8.40; used 2,600 sheets
Direct Labor
Regular time
5,200 hours at $16 (pre contract settlement)
Regular time
900 hours at $17 (post contract settlement)
Variable Overhead
$23,300 (based on 4,175 machine hours)
Fixed Overhead
$18,850 (based on 4,175 machine hours)
Determine the following:
a. Total material price variance
b. Total material usage (quantity) variance
c. Labor rate variance
d. Labor efficiency variance
e. Variable overhead spending variance
f. Variable overhead efficiency variance
g. Fixed overhead spending variance
h. Volume variance
i. Budget variance
Direct Material
Aluminum
4 sheets at $4
$ 16
Copper
3 sheets at $8
24
Direct labor
7 hours at $16
112
Variable overhead
5 machine hours at $6
30
Fixed overhead
5 machine hours at $4
20
Overhead rates were based on normal monthly capacity of 6,000 machine hours.
During November, the company produced only 850 units because of a labor strike, which occurred during union contract negotiations. After the dispute was settled, the company scheduled overtime to try to meet regular production levels. The following costs were incurred in November:
Material
Aluminum
4,000 sheets purchased at $3.80; used 3,500 sheets
Copper
3,000 sheets purchased at $8.40; used 2,600 sheets
(Variances and variance responsibility) Namathe Industries manufactures children’s footballs with the following standard costs per unit:
Material: one square foot of leather at $2.00
$ 2.00
Direct labor: 1.6 hours at $9.00
14.40
Variable overhead cost
3.00
Fixed overhead cost
3.00
Total cost per unit
$22.40
Per unit overhead cost was calculated from the following annual overhead budget for180,000 footballs.
Variable Overhead Cost
Indirect labor—90,000 hours at $7.00
$630,000
Supplies (oil)—180,000 gallons at $0.50
90,000
Allocated variable service department costs
90,000
$ 810,000
Total variable overhead cost
Fixed Overhead Cost
Supervision
$ 81,000
Depreciation
135,000
Other fixed costs
45,000
Total fixed overhead cost
261,000
Total budgeted overhead cost at 180,000 units
$1,071,000
Following are the charges to the manufacturing department for November when 15,000 units were produced:
Material (15,900 square feet at $2.00)
$ 31,800
Direct labor (24,600 hours at $9.10)
223,860
Indirect labor (7,200 hours at $7.10)
51,120
Supplies (oil) (18,000 gallons at $0.55)
9,900
Allocated service department variable OH costs
9,600
Supervision
7,425
Depreciation
11,250
Other fixed costs
3,750
Total
$348,705
Purchasing normally buys about the same quantity as is used in production during a month. In November, the company purchased 15,600 square feet of material at a price of $2.10 per foot.
a. Calculate the following variances from standard costs for the data given:
1. Material purchase price
2. Material quantity
3. Direct labor rate
4. Direct labor efficiency
5. Overhead budget
b. The company has divided its responsibilities so that the Purchasing Department is responsible for the purchase price of materials and the Manufacturing Department is responsible for the quantity of materials used. Does this division of responsibilities solve the conflict between price and quantity variances? Explain your answer.
c. Prepare a report detailing the overhead budget variance. The report, which will be given to the Manufacturing Department manager, should only show that part of the variance which is her responsibility and should highlight the information in ways that would be useful to her in evaluating departmental performance and when considering corrective action.
d. Assume that the departmental manager performs the timekeeping function for this manufacturing department. From time to time, analyses of overhead and direct labor variances have shown that the manager has deliberately misclassified labor hours (i.e., listed direct labor hours as indirect labor hours and vice versa) so that only one of the two labor variances is unfavorable. It is not feasible economically to hire a separate timekeeper. What should the company do, if anything, to resolve this problem?
(Conversion cost variances) Kieffer Company makes men’s suit alterations for a major clothing store chain. No direct materials are used in the alterations process and overhead costs are primarily variable and relate very closely to direct labor charges. The company owner has decided to compute variances on a conversion cost basis. Standards for 2010 are as follows:
Expected direct labor hours (DLHs; to be incurred evenly throughout the year)
60,000
Number of suits altered in October
1,800
Standard DLHs per suit
3
Actual DLHs worked in October 2010
5,490
Budgeted variable conversion cost per DLH
$ 18
Budgeted annual fixed conversion cost
$ 72,000
Actual variable conversion cost for October 2010
$103,100
Actual fixed conversion cost for October 2010
$ 5,750
a. How many suits does Kieffer Company expect to alter during 2010?
b. What is the predetermined fixed OH rate for Kieffer Company?
c. How many standard direct labor hours were allowed for October 2010?
d. Calculate the four conversion cost variances assuming that variable and fixed costs are separated.
e. Calculate the three conversion cost variances assuming that fixed and variable costs are combined.
(Appendix) Polermo Inc. produces three topping, 18 inch frozen pizzas and uses a standard cost system. The three pizza toppings (in addition to cheese) are onions, olives, and mushrooms. To some extent, discretion may be used to determine the actual mix of these toppings. The company has two classes of labor, and discretion also may be used to determine the mix of the labor inputs. The standard cost card for a pizza follows:
Onions
3 ounces at $0.10 per ounce
Olives
3 ounces at $0.35 per ounce
Mushrooms
3 ounces at $0.50 per ounce
Labor category 1
5 minutes at $12 per hour
Labor category 2
6 minutes at $8 per hour
During May 2010, the company produced 48,000 pizzas and used the following inputs:
Onions
8,000 pounds
Olives
12,000 pounds
Mushrooms
8,000 pounds
Labor category 1
5,200 hours
Labor category 2
4,000 hours
During the month there were no deviations from standards on material prices or labor rates.
a. Determine the material quantity, mix, and yield variances.
b. Determine the labor efficiency, mix, and yield variances.
c. Prepare the journal entries to record the above mix and yield variances.
OMB Press Release. The following press release from the Office of Management and Budget was issued November 20, 2007.
FOR IMMEDIATE RELEASE
November 20, 2007
Contact: OMB Communications, 202 395 7254
Federal Agencies Continue to Improve Financial Reporting Results and Eliminate Payment Errors
Washington, DC—For the third year in row, all major Federal agencies successfully met the 45 day financial audit deadline as required by the rigorous reporting guidelines set by the Office of Management and Budget (OMB). Since 2001, agencies are required to complete the financial report 45 days after the end of the Fiscal Year, compared to the previous five month (150 days) window for completion. The accelerated deadline results in more immediate availability of financial information to agency decision makers and requires agencies to employ rigorous disciplines throughout the year to ensure readiness for year end reporting.
In addition to timely reporting, the results from Fiscal Year 2007 show that the Federal government is improving the validity of its financial information.
??Of the 24 major Federal agencies, 19 received clean opinions, one more than the 18 clean opinions reported last year at this time.
??The total number of material weaknesses government wide declined from 41 to 39. This is the fourth year in a row that material weaknesses have declined, with a more than 35% decrease in weaknesses since 2001.
??Five additional agencies received a clean opinion with no material weaknesses, including the Departments of Justice, the Interior, Energy, the Small Business Administration, and the U.S. Agency for International Development. This brings the total number of agencies realizing this important accomplishment to 13, up from just seven in 2001.
The decrease in weaknesses this year is more notable in light of recent changes to government audit guidelines that lower materiality thresholds and have the effect of characterizing more audit findings as “material weaknesses.” In other words, while auditing standards are getting tougher, Federal agencies are more than keeping pace by continuing to decrease the number of material findings.
Required
Choose a federal agency of the U.S. government and locate its annual financial report for the most recent fiscal year from its agency Web site or a government site such Answer the following questions.
a. Did this agency receive an unqualified opinion for the most recent fiscal year? If not, can you determine why?
b. Examine the statements of net cost and changes in net position and determine the amount of operations that was funded by appropriations for this fiscal year. Did the agency report a positive or negative change in net position? Which elements of this financial statement were significantly different from those of the prior year and might have contributed most to the change in net position?
c. Does the agency integrate accountability reports with performance reports produced under the Government Performance and Results Act?
Which of the following is not a true statement about the difference between accounting and reporting for federal government agencies versus state and local governments?
a. The federal government uses a dual track method of accounting for proprietary accounts and budgetary accounts; state and local governments also use budgetary accounting.
b. State and local governments use accrual accounting in the government wide statements as well as proprietary and fiduciary funds; federal agencies use only the cash basis of accounting.
c. The budget is recorded in the general ledger of a state or local government and a federal agency.
d. State and local governments do not account for apportionments and most do not account for allotments.
Statement of Budgetary Resources. The trial balance of the Federal Science Administration, as of August 31, 2011, follows:
Budgetary Accounts
Debits
Credits
Other Appropriations Realized—2011
$4,894,855
Other Appropriations Realized—2010
1,210,210
Unapportioned Authority—2011
$ 200,000
Apportionments—2011
150,000
Allotments—2011
600,000
Commitments—2011
150,000
Undelivered Orders—2011
664,131
Expended Authority—2011
3,130,724
Expended Authority—2010
1,210,210
Total Budgetary Accounts
$6,105,065
$6,105,065
Required
Prepare a statement of budgetary resources for the 11 months ended August 31, 2011, assuming that goods on order at the end of the prior year amounted to $1,210,210.
Transaction Analysis and Statements. Congress authorized the Flood Control Commission to start operations on October 1, 2011.
Required
a. Record the following transactions in general journal form as they should appear in the accounts of the Flood Control Commission. Record all expenses in the Operating/Program Expenses account.
(1) The Flood Control Commission received official notice that the oneyear appropriation passed by Congress and signed by the President amounted to $7,000,000 for operating expenses.
(2) The Office of Management and Budget notified the Commission of the following schedule of apportionments: first quarter, $2,000,000; second quarter, $2,000,000; third quarter, $1,500,000; and fourth quarter, $1,500,000.
(3) The Flood Control Commissioner allotted $1,000,000 for the first month’s operations.
(4) Obligations were recorded for salaries and fringe benefits, $400,000; furniture and equipment, $270,000; materials and supplies, $250,000; and rent and utilities, $50,000. The Commission does not record commitments prior to recording obligations.
(5) Payroll for the first two weeks in the amount of $170,000 was paid.
(6) Invoices approved for payment totaled $395,000; of the total, $180,000 was for furniture and equipment, $175,000 for materials and supplies, and $40,000 for rent.
(7) A liability was recorded for the payroll for the second two weeks, $160,000, and for the employer’s share of FICA taxes for the four weeks, $23,000. (Note: Credit to Accrued Funded Payroll and Benefits.)
(8) Accounts payable totaling $189,000 were paid, which included liabilities for materials and supplies, $149,000, and rent, $40,000. Accrued Funded Payroll and Benefits in the amount of $183,000 were paid.
(9) Accruals recorded at month end were salaries, $30,000, and utilities, $10,000. Materials and supplies costing $60,000 were used during the month. Depreciation of $2,500 was recorded on furniture and equipment for the month. (Note: In practice, this would likely be done in worksheet form for monthly reporting purposes.)
(10) Necessary closing entries were prepared as of October 31, 2011. (Note: Again, for monthly statements, this would be a worksheet entry only.)
b. Prepare the Balance Sheet of the Flood Control Commission as of October 31, 2011, assuming that all of the Commission’s assets are entity assets, Fund Balance with Treasury is intragovernmental, and all other assets are governmental.
c. Prepare the Statement of Changes in Net Position of the Flood Control Commission for the month ended October 31, 2011.
d. Prepare the Statement of Budgetary Resources of the Flood Control Commission for the month ended October 31, 2011.
Single Audit. Background. Mountain Lake Mental Health Affiliates, a nongovernmental not for profit organization, has contacted Bill Wise, CPA, about conducting an annual audit for its first year of operations. The governing board wishes to obtain an audit of the financial statements and, having received favorable information about Mr. Wise’s ability to conduct such audits, has decided not to issue a request for proposals from other audit firms. Cybil Civic, president of the board, heard from a friend associated with a similar organization that $5,000 is an appropriate price for such an audit and has offered Mr. Wise the audit for that price. Although Mr. Wise agrees that $5,000 would be reasonable for a typical financial statement audit of an organization of Mountain Lake’s type and size, he refuses to contract for the audit at that price until he is able to estimate the extent of audit work that would be involved.
Facts. In discussions with Mountain Lake’s controller, Mr. Wise obtains the following information about the organization for the year just ended:
1. Mountain Lake received a $200,000 grant from the City of Mountain Lake, of which 50 percent was stated as being from federal sources. Of this amount, $150,000 was expended during the year, equally from federal and nonfederal sources.
2. Unrestricted gifts of $50,000 were received from private donors; $40,000 was spent during the year.
3. The organization received $300,000 from Medicare for mental health services rendered during the year.
4. A building owned by the U.S. Department of Health and Human Services is occupied by Mountain Lake for rent of $1 per year. The fair value of the rental has been appraised at $30,001.
5. Mountain Lake carried out a program with the Federal Bureau of Prisons to provide alcohol and drug abuse counseling services for prisoners at a nearby federal prison. Services are provided on a “units of service” reimbursement basis. Each unit of service is reimbursed at the rate of $100 and the contract provides for maximum reimbursement of $400,000. Actual units of service for the year were 4,400. Direct costs incurred for these services amounted to $250,000 in total.
Required
a. Based on the foregoing facts, is Mountain Lake Mental Health Affiliates required to have a single audit? Explain your answer.
b. Should Mr. Wise accept the audit engagement for a $5,000 fee? Why or why not?
c. Would Mr. Wise be considered independent according to Government Auditing Standards if he also prepares routine tax filings for the organization? Why or why not?
GAAS, GAGAS, and the Single Audit. A city has approached you concerning the audit of its 2011 financial statements. State law requires the city to have an audit and submit the audited financial report to the state. New elections at the beginning of the fiscal year resulted in a change in the administration of the city. Your firm and the audit firm that conducted the prior year’s audit have been asked by the city to submit bids for the current year’s audit.
Since the new city administration is quite inexperienced, it has not provided you with a formal Request for Proposal (RFP). Therefore, you have the prior year’s audit and financial reports, and little more information than the following for fiscal year 2011.
1. The new city controller is a certified public accountant who worked for a firm that specialized in government audits.
2. For the last three years the city has received a clean audit opinion.
3. The city is receiving grants and other aid from state and federal sources totaling $3,977,000.
4. Total budgeted revenues for the year were $20,980,000 and expenditures were $25,749,000. Approximately 48 percent of revenues are from property taxes.
5. The city has six governmental funds, three enterprise funds, and an agency fund.
6. It is five months until the end of fiscal year 2011.
Required
Prior to determining whether you would be interested in submitting a bid for the audit, you decide to use the information you have to draw up a list of factors that would affect the cost of your bid. Provide your list and explain why each item would affect your fee bid.
Single Audit, Internet Case. A not for profit organization has hired you to conduct an audit. The audit has been requested by the organization’s board of directors. A mission of the organization is to provide for the education of children in the economically distressed area of the city. In fulfilling its mission, the organization operates a Head Start program, a K 3 elementary school, and an after school kids program. To help fund its mission, the organization receives funds from several sources, including federal programs. The federal programs and the amount of funding expended from each program for the fiscal year are as follows:
Required
Prior to determining whether you would be interested in submitting a bid for the audit, you decide to use the information you have to draw up a list of factors that would affect the cost of your bid. Provide your list and explain why each item would affect your fee bid.
Internet Case. The City of Belleview receives pass through funds from the state’s Department of Housing to assist in administering the federally funded Supportive Housing Program for the elderly. At the request of the state’s Department of Housing, the city has engaged you to perform a program specific audit of its expenditures of federal awards for the Supportive Housing Program for the elderly. Although you are unfamiliar with the particular program, you have extensive experience in governmental auditing and have audited many other federal programs.
Required
Utilize the Internet to answer the following questions about this program.
a. What is the Catalog of Federal Domestic Assistance (CFDA) number for this program?
b. Describe the program’s purpose and its eligible beneficiaries.
c. Which of the 14 compliance items (A through N) listed in the Circular A–133 Compliance Supplement are applicable to auditing compliance for this program?
Single Audit Quality. In this chapter, information was provided on the report of the National Single Audit Sampling project. The project was the outgrowth of concern over the quality of single audits. Based on the project’s results, it would appear that there is reason for concern over the quality of audits, given that 35.5 percent of the audits were considered unacceptable. The most commonly cited problems were:
1. Failure to document an understanding of internal controls over compliance requirements.
2. Failure to document testing of internal controls on at least some compliance requirements.
3. Failure to document compliance testing on at least some compliance requirements.
Required
a. Discuss factors you believe may be contributing to the problems related to single audit quality.
b. The project report recommends that all affected parties be involved in the solution. Discuss how you think each of the following three parties could help improve single audit quality.
Audit Committees. The city council members of Laurel City are considering establishing an audit committee as a subset of the council. Several members work for commercial businesses that have recently established such committees in response to the Sarbanes Oxley Act of 2002. They have asked your advice as a partner in the public accounting firm that audits the city’s annual financial statements. They are especially interested in whether the benefits of such a committee outweigh any costs to establishing one.
Required
a. What resources are available to the city to help it use this audit committee efficiently and effectively?
b. Provide a short report to the council that lists the benefits and costs of establishing an audit committee. Explain what qualifications would be expected of council members who sit on this committee and the tasks in which they would be engaged.
Examine the CAFR. Using the CAFR you obtained for Exercise 1–1, answer the following questions:
a. Auditors. Was this CAFR audited by external certified public accountants (CPAs) or by state or local governmental auditors?
b. Audit Opinion. What type of opinion did this entity receive? If it was qualified, what reason was given? Was an opinion expressed on the supplementary information as well as the basic financial statements?
c. Auditing Standards. Did the auditor use generally accepted auditing standards (GAAS), generally accepted government auditing standards (GAS or GAGAS), or both?
d. Paragraphs. How many paragraphs are there in the auditor’s report? Can you identify the introductory, scope, opinion, and any explanatory paragraphs?
e. Single Audit. Can you tell whether this entity was required to have a single audit? If so, are the required single audit reports contained within the cover of the CAFR that you are examining? If the entity does receive federal financial assistance but you see no mention of the single audit in the auditor’s report, where do you expect that single audit report to be?
Continuing Professional Education. As part of your audit firm’s quality control policies, it maintains a record of continuing profession education (CPE) taken by professional staff members. Following is information on some of the classes, sessions, workshops, and conferences that the auditors of your firm have attended in the past year.
1. A session dealing with the source of current revenues and three year projections of revenues for the state.
2. A conference on estate planning.
3. A workshop on “Factors to Consider in Determining the Actuarial Value of Pensions”.
4. A session on the risk assessment suite (SAS 104 111).
5. A session on the role of audit committees and how to form an effective audit committee.
6. An online “Principles of Accounting” course.
7. A workshop on “Federal Grant Administration”.
8. A session on GASB’s derivative standard.
9. A conference on “Helping Individuals Meet Their Long Term Financial Goals” (a financial planning conference).
10. A session on problems associated with implementing an enterprise resource planning system (ERP).
Required
It is your responsibility to determine whether the classes, sessions, workshops, and conferences attended by the auditors could be used to meet the GAGAS requirement that auditors earn 24 hours of CPE in government related areas every two years. In the space to the left of each item, indicate whether the item qualifies (Q) or does not quality (DNQ).
Single Audit. Quad States Community Service Agency expended federal awards during the most recent fiscal year in the following amounts for the programs shown:
Program 1
$5,789,000
Program 6
$389,000
Program 2
350,000
Program 7
191,000
Program 3
1,069,000
Program 8
94,000
Program 4
5,963,000
Program 9
726,000
Program 5
212,000
Program 10
434,000
Additional information indicates that Programs 4 and 10 were audited as major programs in each of the two preceding fiscal years, with no audit findings reported.
Required
a. Which programs would be considered Type A programs and why? Type B programs?
b. Based on the information provided, which programs would you select for audit and why?
c. If you found out that a new manager with no previous experience was now in charge of Program 4, would your answer to part b change? If so how?
(DM & DL variances) In December, Sam Antari, president of Antari Inc. Received the following information from Denise Sweet, the new controller, in regard to November production of travel bags:
November production
4,800 bags
Actual cost of material purchased and used
$14,550
Standard material allowed
0.5 square yard per bag
Material quantity variance
$600 U
Standard price per yard of material
$ 6
Actual hours worked
9,760 hours
Standard labor time per bag
2 hours
Labor rate variance
$1,464 F
Standard labor rate per hour
$17
Antari asked Sweet to provide the following information:
a. Standard quantity of material allowed for November production
b. Standard direct labor hours allowed for November production
c. Material price variance
d. Labor efficiency variance
e. Standard prime (direct material and direct labor) cost to produce one travel bag
f. Actual cost to produce one travel bag in November
g. An explanation for the difference between standard and actual cost; be sure that the explanation is consistent with the pattern of the variances
(OH variances) FUN Inc. has a fully automated production facility in which almost 97 percent of overhead costs are driven by machine hours. As the company’s cost accountant, you have computed the following overhead variances for May:
Variable overhead spending variance
$34,000 F
Variable overhead efficiency variance
41,200 F
Fixed overhead spending variance
28,000 U
Fixed overhead volume variance
20,000 U
The company’s president is concerned about the variance amounts and has asked you to show her how the variances were computed and to answer several questions. Budgeted fixed overhead for the month is $1,000,000; the predetermined variable and fixed overhead rates are, respectively, $20 and $40 per machine hour. Budgeted capacity is 20,000 units.
a. Using the four variance approach, prepare an overhead analysis in as much detail as possible.
b. What is the standard number of machine hours allowed for each unit of output?
c. How many actual hours were worked in May?
d. What is the total spending variance?
e. What additional information about the manufacturing overhead variances is gained by inserting detailed computations into the variable and fixed manufacturing over head variance analysis?
f. How would the overhead variances be closed if the three variance approach were used?
(OH variances) The manager of the Texas Department of Transportation has determined that it typically takes 30 minutes for the department’s employees to register a new car. In Bexar County, the predetermined fixed overhead rate was computed on an estimated 10,000 direct labor hours per month and is $9 per direct labor hour, whereas the predetermined variable overhead rate is $3 per direct labor hour.
During July, 18,800 cars were registered in Bexar County and 9,500 direct labor hours were worked in registering those vehicles. For the month, variable overhead was $27,700 and fixed overhead was $90,800.
a. Compute overhead variances using a four variance approach.
b. Compute overhead variances using a three variance approach.
c. Compute overhead variances using a two variance approach.
(Four OH variances; journal entries) Kemp Manufacturing set 70,000 direct labor hours as the 2010 capacity measure for computing its predetermined variable overhead rate. At that level, budgeted variable overhead costs are $315,000. Kemp will apply budgeted fixed overhead of $140,400 on the basis of 3,900 budgeted machine hours for the year. Both machine hours and fixed overhead costs are expected to be incurred evenly each month.
During March 2010, Kemp incurred 5,900 direct labor hours and 300 machine hours. Actual variable and fixed overhead were $26,325 and $11,400, respectively. The standard times allowed for March production were 5,980 direct labor hours and 290 machine hours.
a. Using the four variance approach, determine the overhead variances for March 2010. b. Prepare all journal entries related to overhead for Kemp Manufacturing for March2010.
(Three OH variances) Munich Ltd. uses a combined overhead rate of $2.90 per machine hour to apply overhead to products. The rate was developed at an expected capacity of 264,000 machine hours; each unit of product requires two machine hours to produce. At 264,000 machine hours, expected fixed overhead for Munich Ltd. is $250,800.
During November, the company produced 11,960 units and used 24,300 ma chine hours. Actual variable overhead for the month was $47,100 and fixed over head was $20,000. Calculate the overhead spending, efficiency, and volume variances for November.
(Variance journal entries) At year end 2010, the trial balance of Pennopscott Corp. showed the following accounts and amounts:
Debit
Credit
Direct Material Inventory
$ 73,200
Work in Process Inventory
87,840
Finished Goods Inventory
131,760
Cost of Goods Sold
1,171,200
Material Price Variance
14,500
Material Quantity Variance
$21,930
Labor Rate Variance
2,200
Labor Efficiency Variance
8,780
VOH Spending Variance
7,200
VOH Efficiency Variance
600
FOH Spending Variance
1,300
Volume Variance
2,950
Assume that, taken together, the variances are believed to be significant. Prepare the journal entries to close the variances at year end. Round any necessary calculations to one decimal point.
(Behavioral implications of standard costing; research) Contact a local company that uses a standard cost system. Make an appointment with a manager at that company to interview her or him on the following issues:
the characteristics that should be present in a standard cost system to encourage positive employee motivation
how a standard cost system should be implemented to positively motivate employees
the meaning of management by exception and how variance analysis often results in the use of this concept
how employee behavior could be adversely affected when “actual to standard” comparisons are used as the basis for performance evaluation
Prepare a short report and an oral presentation based on your interview.
(Cost control evaluation) McNeal Concrete makes precast concrete steps for use with manufactured housing. The company had the following 2010 budget based on expected production of 6,400 units:
Standard Cost
Amount Budgeted
Direct material
$22.00
$140,800
Direct labor
12.00
76,800
Variable overhead
Indirect material
4.20
26,880
Indirect labor
1.75
11,200
Utilities
1.00
6,400
Fixed overhead
Supervisory salaries
80,000
Depreciation
30,000
Insurance
19,280
Total
$391,360
Cost per unit = $391,380 ÷ 6,400 = $61.15
Actual production for 2010 was 7,000 units, and actual costs for the year were as follows:
Direct material used
$161,000
Direct labor
84,600
Variable overhead
Indirect material
28,000
Indirect labor
13,300
Utilities
7,700
Fixed overhead
Supervisory salaries
82,000
Depreciation
30,000
Insurance
17,600
Total
$424,200
Cost per unit = $424,200 ÷ 7,000 = $60.60
The plant manager, Tanzi Palate, whose annual bonus includes (among other factors) 20 percent of the net favorable cost variances, states that he saved the company $3,850 [($61.15 − $60.60) X 7,000]. He has instructed the plant cost accountant to prepare a detailed report to be sent to corporate headquarters comparing each component’s actual per unit cost with the per unit amounts in the preceding annual budget to prove the $3,850 cost savings.
a. Is the actual to budget comparison proposed by Palate appropriate? If his comparison is not appropriate, prepare a more appropriate comparison.
b. How would you, as the plant cost accountant, react if Palate insisted on his comparison? Suggest what alternatives are available to you.
(Ethics; writing) Hotel rooms have become more extravagant over the past decade and the time needed to clean a room has increased. According to a study entitled “Creating Luxury, Enduring Pain” by Unite Here (the primary union representing hotel workers in the United States), housekeepers have the most dangerous jobs at hotels and have an injury rate of more than one in ten workers—almost twice that of other hotel employees. In 2001, the standard number of rooms for a housekeeper to clean had risen from 12 per day to 18 per day. At one pricey hotel chain, it was estimated that a housekeeper who cleaned 15 rooms stripped approximately 500 pounds of soiled linens and replaced those with 500 pounds of clean linens resulting in back and shoulder injuries, carpal tunnel syndrome, and bursitis.
Two articles relating to this situation are Komp, “How Hotel Work Is Hurting Housekeepers,” Ergoweb (May 10, 2006) and Frumin et al., “Workload Related Musculoskeletal Disorders among Hotel Housekeepers: Employer Records Reveal a Growing National Problem” (April 19, 2006).
a. Why is it necessary for hotels to establish a standard for number of rooms to be cleaned by housekeepers?
b. The average annual wages of housekeepers is $17,340, although this may be higher at the larger hotel chains. The large hotel chains are, however, attempting to eliminate health care benefits with the wage increases. Given the rate of job injuries, do you believe that the housekeepers are better off with the lower wage and health care benefits or a higher wage and no health care benefits? Explain.
c. In an 8 hour day (480 minutes), cleaning 15 rooms amounts to approximately32 minutes per room. What makes it difficult for a housekeeper to strip and remake a bed, vacuum, lightly dust, and clean a bathroom in that period of time?
(DL & OH; use of standard cost systems; ethics; writing) Many companies face the prospect of paying workers overtime wages; some of these payments are at time and a half wages.
a. How does overtime pay affect direct labor cost? Variable overhead?
b. Obviously, paying overtime to already employed workers makes better financial business sense than does hiring additional workers. If workers would prefer not to work overtime but do so to maintain their jobs, how does overtime affect the ethical contract between employers and employees?
c. What effects might overtime have on job efficiency? On job effectiveness (such as quality of production)?
d. Would you be in favor of limiting allowable hours of overtime to have more individuals employed? Discuss this question from the standpoint of (1) the government, (2) the employer, (3) a currently employed worker, and (4) an unemployed individual.
(Ethics; writing) An HMO medical program began reimbursing hospitals according to diagnostic related groups (DRGs). Each DRG has a specified standard “length of stay.” If a patient leaves the hospital early, the hospital is financially impacted favorably, but a patient staying longer than the specified time costs the hospital money.
a. From the hospital administrator’s point of view, would you want favorable length of stay variances? How might you try to obtain such variances?
b. From a patient’s point of view, would you want favorable length of stay variances? Answer this question from the point of view of (1) a patient who has had minor surgery and (2) a patient who has had major surgery.
c. Would favorable length of stay variances necessarily equate to high quality care?
(Variances and conversion cost category) Svenson Technology considers direct labor cost too insignificant to separately account for, and, therefore, uses a $22.50 per machine hour predetermined conversion cost rate (of which $16 is related to fixed over head costs). The conversion rate was established based on expected capacity of 1,008,600machine hours. One of Svenson Technology’s products requires 4.1 machine hours to manufacture.
In September 2010, the company manufactured 21,000 units of product and used 83,000 machine hours and 840 direct labor hours. Variable and fixed conversion costs incurred for September were $551,230 and $1,330,000, respectively.
a. What is the expected capacity per month in units and machine hours?
b. Prepare a four and three variance analysis of conversion costs for September 2010.
(Appendix) Bernie Services has three labor classes: administrative assistants, para legals, and attorneys. Standard wage rates are as follows: administrative assistants, $30per hour; paralegals, $60 per hour; and attorneys, $125 per hour. For October, the numbers of actual direct labor hours worked and of standard hours for probate cases were as follows:
Actual DLHs
Number of Standard Hours Allowed
Administrative assistant
900
1,008
Paralegal
2,520
2,772
Attorney
1,500
1,260
a. Calculate October’s direct labor efficiency variance and decompose the total into the following components:
1. direct labor mix variance, and
2. direct labor yield variance.
b. Prepare a memo addressing whether management used an efficient mix of labor.
(DM & DL variances) Schmidt Co. has the following standard material and labor quantities and costs for one unit of Product SWK#468:
Material
1.85 pounds @ $3.50 per pound
Labor
0.04 hours @ $12 per hour
During July, the purchasing agent found a “good deal” on the raw material needed for Product SWK#468 and bought 100,000 pounds of material at $3.15 per pound. In July, the company produced 48,000 units of Product SWK#468 with the following material and labor usage:
Material
95,000 pounds
Labor
2,200 hours @ $12.10 (due to a renegotiated labor contract)
a. What is the standard quantity of material and the standard labor time for July?
b. Calculate the material and labor variances for July.
c. Did the purchasing agent make a “good deal” on the raw material? Explain.
(DM & DL variances; journal entries) Griffon Corp. makes small plastic dog toys with the following material and labor standards:
Standard Quantity
Standard Cost
Material
0.5 pound
$4.00 per pound
Labor
12 minutes
9.00 per hour
During October, 60,000 pounds of material were acquired on account at $4.15 per pound. During October, 50,120 pounds of that were used in production during the month to make 100,000 toys. Factory payroll for October showed 20,600 direct labor hours at a total cost of $182,310.
a. Compute material and labor variances, basing the material price variance on the quantity of material purchased.
b. Assuming a perpetual inventory system is used, prepare the relevant general journal entries for October.
(DM & DL variances) Aquatica uses a standard cost system for materials and labor in producing small fishing boats. Production requires three materials: fiberglass, paint, and a purchased trim package. The standard costs and quantities for materials and labor are as follows:
Standards for One Fishing Boat
2,000 pounds of fiberglass X $1.80 per pound
$3,600
6 quarts gel coat paint X $15.00 per quart
90
1 trim package
200
40 hours of labor X $25.00 per hour
1,000
Standard cost for DM and DL
$4,890
The following actual data related to the production of 600 boats was recorded for July:
Material Purchased on Account
Fiberglass—2,100,000 pounds X $1.83 per pound
Paint—1,000 gallons X $55.50 per gallon
Trim packages—640 X $205 per package
Material Used
Fiberglass—1,380,000 pounds
Paint—924 gallons
Trim packages—608
Direct Labor Used
23,850 hours X $23.50 per hour
Calculate the material and labor variances for Aquatica for July. The material price variance should be computed for each type of material and on the quantity of material purchased.
(Incomplete data; variances) Surgical Products produces latex surgical gloves. Machines perform the majority of the processing for 1,000 pairs of gloves per hour. Each pair of gloves requires 0.85 square foot of latex, which has a standard price of $0.80 per square foot. Machine operators are considered direct labor and are paid $15 per hour.
During one week in May, Surgical Products produced 300,000 pairs of gloves and experienced a $1,440 unfavorable material quantity variance. The company had purchased 2,500 more square feet of material than had been used in production that week. The unfavorable material price variance for the week was $5,186. A $288 unfavorable total labor variance was generated based on 315 total actual labor hours to produce the gloves. Determine the following amounts:
a. Standard quantity of material for production achieved
(Incomplete data; variances) Quinan Carpentry Co. makes wooden shelves. A small fire on October 1 partially destroyed the records relating to September’s production. The charred remains of the standard cost card appear here.
Standard Quantity
Standard Price
Direct material
3.1 board feet
Direct labor
$9.80 per hour
From other fragments of records and several discussions with employees, you learn the following:
The purchasing agent’s files showed that 50,000 board feet had been purchased on account in September at $1.05 per board foot. He was proud of the fact that this price was $0.05 below standard cost per foot.
There was no beginning inventory of raw material on September 1 and, since the raw material storage location is apart from the production facility, the fire caused no damage to the remaining raw material. Fourteen hundred board feet of raw material were on hand on October 1.
The standard quantity of material allowed for September’s production was 49,600 board feet.
The September payroll for direct labor was $39,494 based on 4,030 actual hours worked.
The production supervisor distinctly remembered being held accountable for 30 more hours of direct labor than should have been worked. She was upset because top management failed to consider that she saved hundreds of board feet of material by creative efforts that required extra time.
a. How many units were produced during September?
b. Calculate direct material variances for September.
c. What is the standard number of hours allowed for the production of each unit?
d. Calculate all direct labor variances for September.
e. Prepare general journal entries reflecting direct material and direct labor activity and variances for September, assuming a standard cost, perpetual inventory system.
(Adjusting standards) ALOHA Corp., started in January 2004, manufactures Hawaiian muumuus. At that time, the following material and labor standards were developed:
Material
3.0 yards at $4 per yard
Labor
1.5 hours at $6 per hour
In January 2010, ALOHA Corp. hired a new cost accountant, Anulu Haoki. At the end of the month, Haoki was reviewing the production variances and was amazed tofind that the company’s material and labor standards had never been revised. Actual material and labor data for January, when 17,200 muumuus were produced, follow.
Material
Purchased, 50,000 yards at $4.90
Used 50,000 yards
Labor
17,800 hours at $9.05 per hour
Material prices have risen 4 percent each year beginning in 2004 (six yearsthrough 2009), but the company can now buy at 95 percent of regular price due to increased purchase volume. Also, direct material waste has been reduced from 1/4yard to 1/8 yard per muumuu; waste has always been included in the standard material quantity. Beginning in 2004, each annual labor contract has specified a 7 percent cost of living adjustment. Revision of the plant layout and acquisition of more efficient machinery has decreased the labor time per muumuu by one third since the company began.
a. Determine the material and labor variances based on the company’s original standards.
b. Determine the new standards against which Haoki should measure the January 2010 results. (Round adjustments annually to the nearest cent.)
c. Compute the variances for material and labor using the revised standards.
(OH variances) Pier Corp. has an expected monthly capacity of 9,000 units but only 5,700 units were produced and 6,000 direct labor hours were used during August 2010 due to a flood in the manufacturing facility. Actual variable overhead for August was $48,165 and actual fixed overhead was $140,220.
Standard cost data follow:
Standard Cost per Unit
(One Unit Takes One Labor Hour)
Direct material
$ 9.00
Direct labor
15.00
Variable overhead
8.00
Fixed overhead
16.00
Total
$48.00
a. Compute and compare the actual overhead cost per unit with the expected overhead cost per unit.
b. Calculate overhead variances using the four variance method.
(OH variances; journal entries) N Joy makes wooden picnic tables, swings, and benches. Standard hours for each product are as follows:
Picnic table
10 standard direct labor hours
Swing
3 standard direct labor hours
Bench
7 standard direct labor hours
The standard variable overhead rate is $4 per direct labor hour. The standard fixed overhead rate, computed using an expected annual capacity of 36,000 direct labor hours, is $2 per direct labor hour. The company estimates stable fixed overhead costs and direct labor hours each month of the annual period. March production was 100 picnic tables, 400 swings, and 60 benches; production required 2,780 actual direct labor hours. Actual variable and fixed overhead for March were $12,800 and $5,900, respectively.
a. Prepare a variance analysis using the four variance approach. (Hint: Convert the production of each type of product into standard hours for all work accomplished for the month.)
b. Prepare journal entries to record actual overhead costs, application of overhead to production, and closing of the overhead variance accounts (assuming those variances are immaterial).
c. Evaluate the effectiveness of the managers in controlling costs.
(Two departments; WA) Always Christmas makes artificial Christmas trees in two departments: Cutting and Boxing. In the Cutting Department, wire wrapped with green “needles” is placed into production at the beginning of the process and is cut to various lengths. The “branches” are then transferred to the Boxing Department, where the lengths are separated into the necessary groups to make a tree. The “limbs” are then placed in boxes and immediately sent to Finished Goods.
The following data are available related to the October 2010 production in each of the two departments:
PERCENT OF COMPLETION
Units
Transferred In
Material
Conversion
Cutting Department
Beginning WIP Inventory
8,000
N/A
100
40
Started in process
36,000
Ending inventory
3,600
N/A
100
70
Boxing Department
Beginning WIP Inventory
2,500
100
0
65
Transferred in
?
Ending inventory
1,200
100
0
70
COSTS
Transferred In
Material
Conversion
Cutting Department
Beginning WIP Inventory
N/A
$ 293,000
$ 80,000
Current period
N/A
1,379,000
1,293,440
Boxing Department
Beginning WIP Inventory
$166,420
$ 0
$ 6,993
Current period
?
383,640
246,120
a. Prepare a cost of production report for the Cutting Department assuming a weighted average method.
b. Using the data developed from part (a), prepare a cost of production report for the Boxing Department assuming a weighted average method.
(Cost flows: multiple departments) Elijah Inc. produces accent stripes for automobiles in 50 inch rolls. Each roll passes through three departments (Striping, Adhesion, and Packaging) before it is ready for shipment to customers. Product costs are tracked by department and assigned using a process costing system. Overhead is applied to production in each department at a rate of 80 percent of the department’s direct labor cost.
The following T account information pertains to departmental operations for June 2010:
Work in Process—Striping
Work in Process—Adhesion
Beginning
20,000
Beginning
70,000
DM
90,000
Transferred in
?
DL
80,000
?
?
DM
22,600
?
480,000
Overhead
?
DL
?
Overhead
?
Ending
17,000
Ending
20,600
Work in Process—Packaging
Finished Goods
Beginning
150,000
Beginning
185,000
Transferred
?
TI
880,000
?
720,000
DM
?
CGM
?
DL
?
Overhead
90,000
Ending
?
Ending
40,000
a. What was the cost of goods transferred from the Striping Department to the Adhesion Department for the month?
b. How much direct labor cost was incurred in the Adhesion Department? How much overhead was assigned to production in the Adhesion Department for the month?
c. How much direct material cost was charged to products in the Packaging Department?
d. Prepare the journal entries for all interdepartmental transfers of products and the cost of the units sold during June 2010.
(Comprehensive; FIFO; two departments) Keep In makes fencing in a two stage production system. In the Cutting Department, wood is cut and assembled into 6 foot fence sections. In the Coating Department, the sections are pressure treated to resist the effects of weather and then coated with a preservative. The following production and cost data are available for March 2010 (units are 6 foot fence sections):
Units
Cutting Dept.
Coating Dept.
Beginning WIP Inventory (March 1)
1,300
900
Complete as to material
80%
0%
Complete as to conversion
75%
60%
Units started in March
4,800
?
Units completed in March
?
4,500
Ending WIP Inventory (March 31)
1,100
?
Complete as to material
40%
0%
Complete as to conversion
20%
40%
Costs
Beginning WIP Inventory
Transferred in
n/a
$11,840
Material
$ 8,345
0
Conversion
7,720
1,674
Current
Transferred in
n/a
?
Material
35,200
4,950
Conversion
21,225
11,300
a. Prepare EUP schedules for both the Cutting and Coating Departments.
b. Determine the cost per EUP for the Cutting Department.
c. Assign costs to goods transferred out of and in ending WIP Inventory in the Cutting Department.
d. Determine the cost per EUP in the Coating Department. Use the modified FIFO basis and round to the nearest penny.
e. Assign costs to goods transferred out of and in ending WIP Inventory in the Coating Department.
(Standard process costing) Donbrowski Co. manufactures reflective lenses and uses a standard process costing system. For May 2010, the following data are available:
Standard Cost of 1 Unit
Direct material
$ 5.50
Conversion
12.50
Total manufacturing cost
$18.00
Beginning WIP Inventory
10,000 units (100% DM; 70% conversion)
Started in May
180,000 units
Completed in May
150,000 units
Ending WIP Inventory
? units (100% DM; 60% conversion)
Actual costs for May:
Direct material
$1,001,000
Conversion
2,136,000
Total actual cost
$3,137,000
a. Prepare an equivalent units of production schedule.
b. Prepare a cost of production report and assign costs to goods transferred and to inventory.
c. Calculate and label the variances and close them to Cost of Goods Sold.
(Multiproduct; hybrid costing) Be at Ease Industries manufactures a series of three models of molded plastic chairs: standard (without arms), deluxe (with arms), and executive (with arms and padding). All are variations of the same design. The company uses batch manufacturing and has a hybrid costing system.
Be at Ease has an extrusion operation and subsequent operations to form, trim, and finish the chairs. Plastic sheets are produced by the extrusion operation, some of which are sold directly to other manufacturers. During the forming operation, the remaining plastic sheets are molded into chair seats and the legs are added; the standard model is sold after this operation. During the trim operation, the arms are added to the deluxe and executive models, and the chair edges are smoothed. Only the executive model enters the finish operation where the padding is added. All units produced complete the same steps within each operation.
The July production run had a total manufacturing cost of $898,000. The units of production and direct material costs incurred were as follows:
Units
Extrusion
Form
Trim
Finish
Produced
Materials
Materials
Materials
Materials
Plastic sheets
5,000
$ 60,000
Standard model
6,000
72,000
$24,000
Deluxe model
3,000
36,000
12,000
$ 9,000
Executive model
2,000
24,000
8,000
6,000
$12,000
Totals
16,000
$192,000
$44,000
$15,000
$12,000
Manufacturing costs applied during July were as follows:
Extrusion
Form
Trim
Finish
Operation
Operation
Operation
Operation
Direct labor
$152,000
$60,000
$30,000
$18,000
Factory overhead
240,000
72,000
39,000
24,000
a. For each product produced by Be at Ease during July, determine the
1. Unit cost.
2. Total cost.
Account for all costs incurred during the month, and support your answer with appropriate calculations.
b. Without prejudice to your answer in part (a), assume that only 1,000 units of the deluxe model remained in the Work in Process Inventory at the end of the month. These units were 100 percent complete as to material and 60 percent complete as to conversion in the trim operation. Determine the value of the1,000 units of the deluxe model in Be at Ease’s Work in Process Inventory at the end of July.
(WA; normal and abnormal loss) Turkburg produces frozen turkey patties. In the Forming Department, ground turkey is formed into patties and cooked; an acceptable shrinkage loss for this department is 1 percent of the pounds started. The patties are then transferred to the Finishing Department where they are placed on buns, boxed, and frozen.
Turkburg uses a weighted average process costing system and has the following production and cost data for the Forming Department for May 2010:
Beginning WIP Inventory (80% complete as to conversion)
2,000 pounds
Started
250,000 pounds
Transferred to Finishing (357,300 patties)
238,200 pounds
Ending inventory (30% complete as to conversion)
6,000 pounds
Beginning inventory cost of turkey
$ 1,807
May cost of turkey
$240,208
Beginning inventory conversion cost
$ 150
May conversion cost
$ 24,380
a. What is the total shrinkage (in pounds)?
b. How much of the shrinkage is classified as normal? How is it treated for accounting purposes?
c. How much of the shrinkage is classified as abnormal? How is it treated for accounting purposes?
d. What are the May 2010 equivalent units of production in the Forming Department for direct materials and conversion?
e. What is the total cost of the patties transferred to the Finishing Department? Cost of ending inventory? Cost of abnormal spoilage?
f. How might Turkburg reduce its shrinkage loss? How, if at all, would your solution(s) affect costs and selling prices?
g. What might have been the cause of the abnormally high spoilage in May? Use calculations to support your answer.
(WA; normal and abnormal discrete spoilage) Gary’s Tools manufactures one of its products in a two department process. A separate Work in Process Inventory account is maintained for each department, and the company uses a weighted average process costing system. The first department is Molding; the second is Grinding. At the end of production in Grinding, a quality inspection is made and then packaging is added. Overhead is applied in the Grinding Department on a machine hour basis. Production and cost data for the Grinding Department for August 2010 follow
a. Prepare the August cost of production report for the Grinding Department. Gary’s Tools assigns the cost of normal spoilage only to the products that are transferred out. As such, the company extends both the normal and abnormal spoilage units in the EUP schedule to all cost components except packaging (as packaging is not added to spoiled units). The cost of normal spoilage is attached to the units transferred to Finished Goods Inventory; the cost of abnormal spoilage is considered a period loss.
b. Prepare the journal entry to dispose of the cost of abnormal spoilage.
(WA; normal and abnormal discrete spoilage) Strongarm manufactures various lines of bicycles. Because of the high volume of each type of product, the company employs a process cost system using the weighted aver age method to determine unit costs. Bicycle parts are manufactured in the Molding Department and transferred to the Assembly Department where they are partially assembled. After assembly, the bicycle is sent to the Packing Department.
Annual cost and production figures for the Assembly Department follow:
PRODUCTION DATA
Beginning WIP Inventory (100% complete as to transferred in;
100% complete as to material; 80% complete as to conversion)
3,000 units
Transferred in during the year (100% complete as to transferred in)
45,000 units
Transferred to Packing
40,000 units
Ending WIP Inventory (100% complete as to transferred in;
50% complete as to material; 20% complete as to conversion)
4,000 units
COST DATA
Transferred In
Direct Material
Conversion
Beginning WIP Inventory
$ 82,200
$ 6,660
$ 13,930
Current period
1,237,800
96,840
241,430
Totals
$1,320,000
$103,500
$255,360
Damaged bicycles are identified on inspection when the assembly process is complete. The normal rejection rate for damaged bicycles is 5 percent of those reaching the inspection point. Any damaged bicycles above the 5 percent quota are considered to be abnormal. Damaged bikes are removed from the production process, and, when possible, parts are reused on other bikes. However, such salvage is ignored for the purposes of this problem.
Strongarm does not want to assign normal spoilage cost either to the units in ending inventory (because they have not yet been inspected) or to the bikes that are considered “abnormal spoilage.” Thus, the company includes both normal and abnormal spoilage in the equivalent units schedule (at the appropriate percentage of completion).The cost of the normal spoilage is then added to the bikes transferred to the Packing Department. Abnormal spoilage is treated as a period loss.
a. Compute the number of damaged bikes that are considered to be
1. Normal spoilage.
2. Abnormal spoilage.
b. Compute the weighted average equivalent units of production for the year for
1. Bicycles transferred in from the Molding Department.
2. Bicycles produced with regard to Assembly material.
3. Bicycles produced with regard to Assembly conversion.
c. Compute the cost per equivalent unit for the fully assembled bicycle.
d. Compute the amount of total production cost that will be associated with the following items:
1. Normal damaged units.
2. Abnormal damaged units.
3. Good units completed in the Assembly Department.
4. Ending Work in Process Inventory in the Assembly Department.
e. What amount will be transferred to the Packing Department?
f. Discuss some potential reasons for spoilage to occur in this company. Which of these reasons would you consider important enough to correct and why? How might you attempt to correct these problems?
(WA; normal and abnormal discrete spoilage) LaToya Company produces door pulls, which are inspected at the end of production. Spoilage may occur because the door pull is improperly stamped or molded. Any spoilage in excess of 3 percent of the completed good units is considered abnormal. Direct material is added at the start of production. Labor and overhead are incurred evenly throughout production.
The company’s May 2010 production and cost data follow:
Beginning WIP Inventory (50% complete)
5,600
Units started
74,400
Good units completed
70,000
Ending WIP Inventory (1/3 complete)
7,500
DM
Conversion
Total
Beginning inventory
$ 6,400
$ 1,232
$ 7,632
Current period
74,400
31,768
106,168
Total
$80,800
$33,000
$113,800
Calculate the equivalent units schedule, prepare a weighted average cost of production report, and assign all costs. LaToya extends both the normal and abnormal spoilage units in the EUP schedule to all cost components that have been incurred to the point of detection (100 percent completion). The cost of normal spoilage is attached to the units transferred to Finished Goods Inventory; the cost of abnormal spoilage is considered a period loss.
Filano Corp. has the following standards for one unit of product:
Direct material: 80 pounds X $6
$480
Direct labor: 3 hours X $16 per hour
48
Variable overhead: 1.5 hours of machine time X $50 per hour
75
Fixed overhead: 1.5 hours of machine time X $30 per hour
45
The predetermined OH rates were developed using a practical capacity of 6,000 units per year. Production is assumed to occur evenly throughout the year.
During May 2010, the company produced 525 units. Actual data for May 2010 are as follows:
Direct material purchased: 45,000 pounds X $5.92 per pound
Direct material used: 43,020 pounds (all from May’s purchases)
Total labor cost: $24,955 for 1,550 hour
Variable overhead incurred: $43,750 for 800 hours of machine time
Fixed overhead incurred: $22,800 for 800 hours of machine time
Required:
a. Calculate the following:
1. Material price variance based on purchases
2. Material quantity variance
3. Labor rate variance
4. Labor efficiency variance
5. Variable overhead spending and efficiency variances
6. Fixed overhead spending and volume variances
7. Overhead variances using a three variance approach
8. Overhead variances using a two variance approach
9. Overhead variance using a one variance approach
(Developing standard cost card; discussion) One of Sure Bet Sherbet’s best selling products is raspberry sherbet, which is manufactured in 10 gallon batches. Each batch requires 6 quarts of raspberries. The raspberries are sorted by hand before entering the production process and, because of imperfections, 1 quart of berries is discarded for every 4 quarts of acceptable berries. The standard direct labor sorting time to obtain 1 quart of acceptable raspberries is 3 minutes. After sorting, raspberries are blended with other ingredients; blending requires 12 minutes of direct labor time per batch. During the blending process, some sherbet is lost because it adheres to the blending vats. After blending, the sherbet is packaged in quart containers. The following cost information is relevant:
Raspberries are purchased for $0.80 per quart.
All other ingredients cost a total of $0.45 per gallon.
Direct labor is paid $9.00 per hour.
The total cost of material and labor required to package the sherbet is $0.38 per quart.
a. Develop the standard cost for the direct cost components of a 10 gallon batch of raspberry sherbet. The standard cost should identify standard quantity, standard price/rate, and standard cost per batch for each direct cost component.
b. Discuss the possible causes of unfavorable material price variances, and identify the individual(s) who should be held responsible for these variances.
c. Discuss the possible causes of unfavorable labor efficiency variances, and identify the individual(s) who should be held responsible for these variances.
(DM variances) In November 2010, Day Time Publishing Company’s costs and quantities of paper consumed in manufacturing its 2011 Executive Planner and Calendar were as follows:
Actual unit purchase price
$0.13 per page
Standard unit price
$0.14 per page
Standard quantity for good production
97,900 pages
Actual quantity purchased during November
115,000 pages
Actual quantity used in November
100,000 pages
a. Calculate the total cost of purchases for November.
b. Compute the material price variance (based on quantity purchased).
(DM variances) Cave Company produces a product called Lem. The standard direct material cost to produce one unit of Lem is 4 quarts of raw material at $2.50 per quart. During May 2010, 4,200 quarts of raw material were purchased at a cost of $10,080. All the purchased material was used to produce 1,000 units of Lem.
a. Compute the actual cost per quart and the material price variance for May 2010.
b. Assume the same facts except that Cave Company purchased 5,000 quarts of material at the previously calculated cost per quart, but used only 4,200 quarts. Compute the material price variance and material usage variance for May 2010, assuming that Cave identifies variances at the earliest possible time.
c. Which managers at Cave Company would most likely assume responsibility for control of the variance computed in requirement (b)?
(DM variances) Ayesha Inc. manufactures a product that requires 5 pounds of material. The purchasing agent has an opportunity to purchase the necessary material at a vendor’s bankruptcy sale at $1.40 per pound rather than the standard cost of $2.10 per pound. The purchasing agent purchases 100,000 pounds of material on May 31.During the next four months, the company’s production and material usage was as follows:
Production
Quantity Used
June
3,000
16,400 lb.
July
3,400
17,540 lb.
August
2,900
14,950 lb.
September
2,500
13,200 lb.
a. What is the material price variance for this purchase?
b. What is the material quantity variance for each month for this material?
c. What might be the cause of the unfavorable material quantity variances?
(DL variances) Calista & Lane, CPAs, set the following standard for its inventory audit of Triumph Co.: 350 hours at an average hourly billing rate of $250.The firm actually worked 330 hours during the inventory audit process. The total labor variance for the audit was $3,500 unfavorable.
a. Compute the total actual payroll.
b. Compute the labor efficiency variance.
c. Compute the labor rate variance.
d. Prepare the entry to assign labor costs to inventory, record the labor variances, and accrue payroll costs.
e. Write a memo to the appropriate personnel regarding feedback about the labor efficiency variance. The memo should also offer a brief explanation that is consistent with the labor rate and efficiency variances.
(DM & DL variances) In July 2010, Zinger Corp. purchased 20,000 gallons of Numerol for $61,000 to use in the production of product #43MR7. During July, Zinger Corp. manufactured 3,900 units of product #43MR7. The following information is available about standard and actual quantities and costs:
Standard for One Unit
Actual Usage for July
Direct material
4.8 gallons @ $3 per gallon
18,350 gallons
Direct labor
20 minutes @ $9 per DLH
1,290 DLHs @ $9.02 per DLH
a. Compute the material purchase price variance and the material quantity variance.
b. Compute the labor rate, labor efficiency, and total labor variance.
During the second quarter, the company purchased 17,000 square yards at a cost of $83,300 and used 16,500 square yards to produce 1,500 Curtain #4571s. Direct labor totaled 7,600 hours for $79,800.
a. Compute the material price and usage variances.
b. Prepare the journal entries for the purchase and use of direct material.
c. Compute labor rate and labor efficiency variances.
d. Prepare the journal entry to accrue direct labor cost and record the labor variances for the quarter.
e. Comment on the above variances. Identify possible causes and relationships among the variances that you computed.
(WA EUP; second department) Lamb Inc. produces calendars in a two process, two department operation. In the Printing Department, calendars are printed and cut. In the Assembly Department, the material received from Printing is assembled into individual calendars and bound. Each department maintains its own Work in Process Inventory, and costs are assigned using weighted aver age process costing. In Assembly, conversion costs are incurred evenly through out the process; direct material is added at the end of the process. For September2010, the following production and cost information is available for the Assembly Department:
Beginning WIP Inventory: 5,000 calendars (30% complete as to conversion); transferred in cost, $7,550; conversion cost, $1,093
Transferred in during September: 80,000 calendars
Current period costs: transferred in, $80,000; direct material, $10,270; conversion, $13,991
Ending WIP Inventory: 6,000 calendars (80% complete as to conversion)
For the Assembly Department, compute the following:
a. equivalent units of production for each cost component
(FIFO EUP; second department) Lamb Inc. produces calendars in a two process, two department operation. In the Printing Department, calendars are printed and cut. In the Assembly Department, the material received from Printing is assembled into individual calendars and bound. Each department maintains its own Work in Process Inventory, and costs are assigned using weighted aver age process costing. In Assembly, conversion costs are incurred evenly through out the process; direct material is added at the end of the process. For September2010, the following production and cost information is available for the Assembly Department:
Beginning WIP Inventory: 5,000 calendars (30% complete as to conversion); transferred in cost, $7,550; conversion cost, $1,093
Transferred in during September: 80,000 calendars
Current period costs: transferred in, $80,000; direct material, $10,270; conversion, $13,991
Ending WIP Inventory: 6,000 calendars (80% complete as to conversion)
Use the information and assume that Lamb Inc. uses the FIFO method of process costing. For the Assembly Department, compute the following:
a. equivalent units of production for each cost component
(WA & FIFO EUP; two departments) Baum Co. has two processing departments: Fabrication and Assembly. In the Fabrication Department, metal is cut and formed into various components, which are then transferred to Assembly. The components are welded, polished, and coated with sealant in the Assembly Department. April 2010 production data for these two departments follow.
Fabrication
Beginning WIP Inventory (100% complete as to material;
5,000
25% complete as to conversion)
Units started during month
40,000
Ending WIP Inventory (100% complete as to material;
6,800
60% complete as to conversion)
Assembly
Beginning WIP Inventory (0% complete as to sealant;
2,000
35% complete as to conversion)
Units started during month
?
Ending WIP Inventory (0% complete as to sealant;
6,100
15% complete as to conversion)
a. Determine the equivalent units of production for each cost component for each department under the WA method.
b. Determine the equivalent units of production for each cost component for each department under the FIFO method.
(Standard process costing) Najm Company uses a standard costing system to account for its pita bread manufacturing process. The bread is sold in packages of one dozen pieces. The company has set the following cost standards for each package:
Direct material—ingredients
$0.25
Direct material—packaging
0.05
Direct labor
0.07
Overhead
0.31
Total cost
$0.68
On June 1, the company had 12,000 pitas in process; these were 100 percent complete as to ingredients, 0 percent complete as to packaging, and 70 percent complete as to labor and overhead. During June, 310,000 pitas were started and 314,000 were finished. Ending inventory was 100 percent complete as to ingredients, 0 percent complete as to the packaging, and 60 percent complete as to labor and overhead.
a. What were the equivalent units of production for June for each cost component?
b. What was the cost of the packages transferred to Finished Goods Inventory during June?
c. What was the cost of the ending WIP Inventory for June?
(Hybrid costing) Batwings makes one size fits most capes. Each cape goes through the same conversion process, but three types of fabric (Dacron, denim, and cotton) are available. The company uses a standard costing system, and standard costs for each type of cape follow.
Dacron
Denim
Cotton
Material (2 yards)
$10
$ 8
$12
Direct labor (1 hour)
9
9
9
Overhead (based on 1.5 machine hours)
6
6
6
Total
$25
$23
$27
Material is added at the start of production. In March 2010, there was no beginning WIP Inventory and 2,500 capes were started into production. Of these, 300 were Da cron, 500 were denim, and 1,700 were cotton. At the end of March, 100 capes (50 Dacron, 20 denim, and 30 cotton) were not yet complete. The stage of completion for each cost component for the 100 unfinished capes is as follows:
Material
100% complete
Direct labor
25% complete
Overhead
35% complete
a. Determine the total cost of the capes completed and transferred to Finished Goods Inventory.
b. Determine the total cost of the capes in the ending WIP Inventory.
(Hybrid costing) Pat Koontz makes necklaces from glass beads, metal beads, and natural beads. After reading about hybrid costing, she realized that the different types of necklaces did not cost the same amount of money to make, even though they took the same amount of time and effort to assemble. Koontz developed the following standard costs for each type of necklace:
Glass
Metal
Natural
Beads
$24
$15
$ 7
Direct labor (1.5 hours)
15
15
15
Overhead (based on 1.5 hours)
8
8
8
Total
$47
$38
$30
Koontz began 2010 with no beginning WIP Inventory after she experienced an extreme holiday rush. During January, 130 necklaces were started: 70 were glass, 25 were metal, and 35 were natural. At the end of January, 25 necklaces were not yet complete: 5 glass,13 metal, and 7 natural. The stage of completion for each cost component for the 25 unfinished necklaces was as follows:
Material
100% complete
Conversion
60% complete
a. Calculate the cost of necklaces completed during January.
b. Calculate the cost of necklaces in ending WIP Inventory.
(FIFO EUP computations; normal loss) Oehkle Inc. produces paint in a process in which spoilage occurs continually. Spoilage of 2 percent or fewer of the gallons of raw material placed into production is considered normal. The following operating statistics are available for June 2010:
Beginning WIP Inventory (60% complete as to material; 70% complete as to conversion)
16,000 gallons
Started during June
360,000 gallons
Ending WIP Inventory (40% complete as to material; 20% complete as to conversion)
8,000 gallons
Spoiled
2,800 gallons
a. How many gallons were transferred out?
b. What are the FIFO equivalent units of production for material? For conversion?
(FIFO; normal loss) Lilliputian Inc. produces dog food. All direct material is entered at the beginning of the process. Some shrinkage occurs during the production process, but management considers any shrinkage of less than 8 percent to be normal. October 2010 data are as follows:
Beginning WIP Inventory (45% complete as to conversion)
36,000 pounds
Started during the month
120,000 pounds
Transferred to FG Inventory
126,000 pounds
Ending WIP Inventory (15% complete as to conversion)
21,600 pounds
Loss
? pounds
The following costs are associated with October product in:
Beginning WIP Inventory:
Material
$14,000
Conversion
10,800
$24,800
Current period:
Material
$39,060
Conversion
33,912
72,972
Total cost to account for
$97,772
Prepare an October 2010 cost of production report for Lilliputian Inc. using FIFO process costing.
(WA; normal vs. abnormal spoilage) Hebert Industries uses a weighted average process costing system. Management has specified that the normal loss from shrinkage cannot exceed 3 percent of the units started in a period. All raw material is added at the start of the production process. Spoilage is determined upon inspection at the end of the production process. March processing information follows.
Beginning WIP Inventory (30% complete as to conversion)
20,000 units
Started during March
120,000 units
Completed during March
116,400 units
Ending WIP Inventory (20% complete as to conversion)
16,000 units
a. How many total units are there to account for?
b. How many units were spoiled during processing? Of the spoiled units, how many should be treated as a normal loss? As an abnormal loss?
c. What are the equivalent units of production for direct material? For conversion?
d. How are costs associated with the company’s normal spoilage handled?
e. How are costs associated with the company’s abnormal spoilage handled?
(FIFO; normal and abnormal loss) Omaha Foods manufactures corn meal in a continuous, mass production process. Corn is added at the beginning of the process. Normal losses are minimal and abnormal losses infrequently occur when foreign materials are found in the corn meal. Routine inspection occurs at the 95 percent completion point as to conversion.
During May, a machine malfunctioned and dumped salt into 8,000 pounds of corn meal. This abnormal loss occurred when conversion was 70 percent complete on those pounds of product. The error was immediately noticed, and those pounds of corn meal were pulled from the production process. Two thousand additional pounds of meal were detected as unsuitable at the routine inspection point; this amount was considered within normal limits. Production data for the month follow.
Beginning WIP Inventory (85% complete)
40,000 pounds
Started during the month
425,000 pounds
Ending WIP Inventory (25% complete)
10,000 pounds
a. Determine the number of EUP for direct material and for conversion, assuming a FIFO cost flow.
b. If the costs per EUP are $0.08 and $0.15 for direct material and conversion, respectively, what is the cost of the ending WIP Inventory?
c. What is the cost of abnormal loss? How is this cost treated in May?
(WA EUP & cost assignment) Ro Day O Inc. manufactures belt buckles in a single step production process. The following information is available for June2010:
Cost of
Whole Units
Material
Cost of Labor
Beginning work in process
200,000
$1,200,000
$1,728,000
Units started during period
1,000,000
7,800,000
9,612,000
Units in ending inventory
300,000
Beginning inventory units were 100 percent complete as to material and 80 percent complete as to labor. The ending inventory units were 100 percent complete as to material and 50 percent complete as to labor. Overhead is applied to production at the rate of 60 percent of direct labor cost.
a. Prepare a schedule to compute equivalent units of production by cost component assuming the weighted average method.
b. Determine the unit production costs for material and conversion.
c. Calculate the costs assigned to completed units and ending inventory for August2010.
(WA EUP; cost assignment) Spangenberg Products manufactures computer cases. All material is added at the start of production and overhead is applied to each product at the rate of 70 percent of direct labor cost. At the beginning of July, there were no units in the Finished Goods Inventory. The firm’s inventory cost records provide the following information:
Units
DM Cost
DL Cost
Work in Process Inventory, 7/1
(70% complete as to labor)
100,000
$ 750,000
$ 215,000
Units started in production
1,500,000
Costs for July
5,650,000
4,105,000
Work in Process Inventory, 7/31
(60% complete as to labor)
400,000
At the end of July, the cost of the Finished Goods Inventory was determined to be $124,000.
a. Compute the following:
1. Equivalent units of production using the weighted average method.
2. Unit production costs for material, labor, and overhead.
3. Cost of goods sold.
b. Prepare the journal entries to record the July transfer of completed goods and the July cost of goods sold.
(WA cost assignment) Fresh Seasons is a contract manufacturer for Delectable Dressing Company. Fresh Seasons uses a weighted average process costing system to account for its salad dressing production. All ingredients are added at the start of the process. Delectable provides reusable vats to Fresh Seasons for the completed product to be shipped to Delectable for bottling, so Fresh Seasons incurs no packaging costs. April2010 production and cost information for Fresh Seasons is as follows:
Gallons of dressing in beginning WIP Inventory
36,000
Gallons completed during April
242,000
Gallons of dressing in ending WIP Inventory
23,500
Costs of beginning WIP Inventory
Direct material
$183,510
Direct labor
98,526
Overhead
78,273
Costs incurred in April
Direct material
$1,136,025
Direct labor
451,450
Overhead
723,195
April beginning and ending WIP inventories had the following percentages of completion for labor and overhead
April 1
April 30
Direct labor
55%
15%
Overhead
70%
10%
a. How many gallons of dressing ingredients were started in April?
b. What is the total cost of the goods transferred out during April?
c. What is the cost of April’s ending WIP Inventory?
(WA cost of production report; journal entries) Delacroix Co. had 800 units of inventory at the beginning of March 2010. Other information about that beginning Work in Process Inventory is as follows:
Quantity: 800 units
Percent Complete
Costs Incurred
Direct material
45
$ 6,748
Direct labor
65
8,680
Overhead
40
5,710
Total beginning inventory
$21,138
Direct labor costs were extremely high during February, because the company had a labor strike and paid a high premium to get production workers that month.
During March, Delacroix Co. started production of 11,400 units of product and incurred $259,012 for material, $58,200 for direct labor, and $188,210 for overhead. At the end of March, the company had 400 units in process (70 percent complete as to material, 90 percent complete as to direct labor, and 80 percent complete as to overhead).
a. Prepare a cost of production report for March using the weighted average method.
b. Journalize the March transactions.
c. Prepare T accounts to represent the flow of costs for Delacroix Co. for March. Use XXX where amounts are unknown and identify what each unknown amount represents.
(FIFO cost per EUP) Itzgood makes a variety of healthy snack foods. The following information for January 2010 relates to a trail mix. Materials are added at the beginning of processing; overhead is applied based on direct labor. The mix is transferred to a second department for packaging. Itzgood’s uses a FIFO process costing system.
Beginning WIP Inventory (40% complete as to conversion)
20,000 pounds
Mix started in January
321,600 pounds
Ending WIP Inventory (80% complete as to conversion)
16,000 pounds
Material cost incurred in January
$778,272
Conversion cost incurred in January
$277,536
Beginning inventory cost totaled $53,580. For January 2010, compute the following:
a. Equivalent units of production for material and conversion.
b. Cost per equivalent unit by cost component.
c. Cost of mix transferred to the packaging department in January.
(FIFO cost assignment) Fresh Seasons is a contract manufacturer for Delectable Dressing Company. Fresh Seasons uses a weighted average process costing system to account for its salad dressing production. All ingredients are added at the start of the process. Delectable provides reusable vats to Fresh Seasons for the completed product to be shipped to Delectable for bottling, so Fresh Seasons incurs no packaging costs. April2010 production and cost information for Fresh Seasons is as follows:
Gallons of dressing in beginning WIP Inventory
36,000
Gallons completed during April
242,000
Gallons of dressing in ending WIP Inventory
23,500
Costs of beginning WIP Inventory
Direct material
$183,510
Direct labor
98,526
Overhead
78,273
Costs incurred in April
Direct material
$1,136,025
Direct labor
451,450
Overhead
723,195
April beginning and ending WIP inventories had the following percentages of completion for labor and overhead
April 1
April 30
Direct labor
55%
15%
Overhead
70%
10%
Use the Fresh Seasons information, except assume that the company uses a FIFO process costing system.
a. How many gallons of dressing ingredients were started in April?
b. What is the total cost of the completed beginning inventory?
c. What is the total cost of goods completed during April?
d. What is the average cost per gallon of all goods completed during April?
e. What is the cost of April’s ending WIP Inventory?
FIFO cost of production report) Delacroix Co. had 800 units of inventory at the beginning of March 2010. Other information about that beginning Work in Process Inventory is as follows:
Quantity: 800 units
Percent Complete
Costs Incurred
Direct material
45
$ 6,748
Direct labor
65
8,680
Overhead
40
5,710
Total beginning inventory
$21,138
Direct labor costs were extremely high during February, because the company had a labor strike and paid a high premium to get production workers that month.
During March, Delacroix Co. started production of 11,400 units of product and incurred $259,012 for material, $58,200 for direct labor, and $188,210 for overhead. At the end of March, the company had 400 units in process (70 percent complete as to material, 90 percent complete as to direct labor, and 80 percent complete as to overhead).
Use the information for Delacroix Co.
a. Prepare a cost of production report for March using the FIFO method.
b. In general, what differences exist between the WA and FIFO methods of process costing and why do these differences exist?
(WA & FIFO; cost of production report) In a single process production system, Phunky Phingers produces wool gloves. For November 2010, the company’s accounting records reflected the
Beginning WIP Inventory (100% complete as to material; 30% complete as to direct labor; 60% complete as to overhead)
12,000 units
Units started during the month
90,000 units
Ending WIP Inventory (100% complete as to material; 40% complete as to direct labor; 80% complete as to overhead)
20,000 units
Cost Component
November 1
During November
Direct material
$13,020
$90,000
Direct labor
1,908
45,792
Overhead
4,636
70,824
a. For November, prepare a cost of production report, assuming that the company uses the weighted average method.
b. For November, prepare a cost of production report, assuming that the company uses the FIFO method.
(WA; second department; advanced) Octavia Corp.’s products are manufactured in three separate departments: Molding, Curing, and Finishing. Materials are introduced in Molding; additional material is added in Curing. The following information is available for the Curing Department for May 2010:
Beginning WIP Inventory (degree of completion: transferred in, 100%; direct material, 80%; direct labor, 40%; overhead, 30%)
8,000 units
Transferred in from Molding
40,000 units
Ending WIP Inventory (degree of completion: transferred in, 100%; direct material, 70%; direct labor, 50%; overhead, 40%)
4,000 units
Transferred to Finishing
? units
Cost Component
BI Cost
Current Period Cost
Transferred in
$200,160
$1,620,000
Direct material
42,504
333,300
Direct labor
31,360
517,880
Overhead
4,848
267,840
Prepare, in good form, a weighted average cost of production report for the Curing Department for May 2010.
(FIFO; second department; advanced) Octavia Corp.’s products are manufactured in three separate departments: Molding, Curing, and Finishing. Materials are introduced in Molding; additional material is added in Curing. The following information is available for the Curing Department for May 2010:
Beginning WIP Inventory (degree of completion: transferred in, 100%; direct material, 80%; direct labor, 40%; overhead, 30%)
8,000 units
Transferred in from Molding
40,000 units
Ending WIP Inventory (degree of completion: transferred in, 100%; direct material, 70%; direct labor, 50%; overhead, 40%)
4,000 units
Transferred to Finishing
? units
Cost Component
BI Cost
Current Period Cost
Transferred in
$200,160
$1,620,000
Direct material
42,504
333,300
Direct labor
31,360
517,880
Overhead
4,848
267,840
Use the information for Octavia Corp, except assume that the company uses FIFO costing. Prepare, in good form, a FIFO cost of production report for the Curing Department for May 2010.
Plaid Clad manufactures golf bags in a two department process: Assembly and Finishing. The Assembly Department uses weighted average costing; the percentage of completion of overhead in this department is unrelated to direct labor. The Finishing Department adds hardware to the assembled bags and uses FIFO costing; overhead is applied in this department on a direct labor basis. For June, the following production data and costs were gathered:
Assembly Department: Units
Beginning WIP Inventory (100% complete for DM;
250
40% complete for DL; 30% complete for OH)
Units started
8,800
Ending WIP Inventory (100% complete for DM;
400
70% complete for DL; 90% complete for OH)
Assembly Department: Costs
DM
DL
OH
Total
Beginning WIP Inventory
$ 3,755
$ 690
$ 250
$ 4,695
Current period
100,320
63,606
27,681
191,607
Total costs
$104,075
$64,296
$27,931
$196,302
Finishing Department: Units
Beginning WIP Inventory (100% complete for transferred in;
100
15% complete for DM; 40% complete for conversion)
Units transferred in
8,650
Ending WIP Inventory (100% complete for transferred in;
200
30% complete for DM; 65% complete for conversion)
Finishing Department: Costs
Transferred In
DM
Conversion
Total
Beginning inventory
$ 2,176
$ 30
$ 95
$ 2,301
Current period
188,570
15,471
21,600
225,641
Total costs
$190,746
$15,501
$21,695
$227,942
Required:
a. Prepare a cost of production report for the Assembly Department.
b. Prepare a cost of production report for the Finishing Department.
c. Prepare T accounts to show the flow of costs through the Assembly and Finishing Departments.
d. Prepare the journal entries for the Finishing Department for June.
(Research) In a team of three or four people, choose a company whose mass production process you would like to study. Use the library, the Internet, and (if possible) personal resources to gather information. Prepare a visual representation of that production process. In this illustration, indicate the approximate percentage of completion points at which various materials are added and where/how labor and overhead flow into and through the process.
Assume that 1,000 units of product are flowing through your production process and are now at the 60 percent completion point as to labor. Prepare a written explanation about the quantity of direct material equivalent units that are included in the 1,000 units. Also explain B4953:B4973have occurred and why the overhead percentage is the same as or different from the percentage of completion for labor.
(WA EUP) In manufacturing its products, Trevano Corp. adds all direct material at the beginning of the production process. The company’s direct labor and overhead are considered to be continuously at the same degree of completion. September production information is as follows:
Beginning WIP Inventory
24,000 pounds
Started during September
600,000 pounds
Completed during September
608,000 pounds
As of September 1, the beginning WIP Inventory was 45 percent complete as to labor and overhead. On September 30, the ending WIP Inventory was 65 percent complete as to conversion.
a. Determine the total number of pounds to account for if Trevano uses the weighted average process costing method.
b. Determine the equivalent units of production for direct material.
c. Determine the equivalent units of production for direct labor and overhead.
(WA EUP) For each of the following situations, use the weighted average method to determine the equivalent units of production for labor and overhead, assuming that they are continuously at the same percentage of completion:
(FIFO EUP) In manufacturing its products, Trevano Corp. adds all direct material at the beginning of the production process. The company’s direct labor and overhead are considered to be continuously at the same degree of completion. September production information is as follows:
Beginning WIP Inventory
24,000 pounds
Started during September
600,000 pounds
Completed during September
608,000 pounds
As of September 1, the beginning WIP Inventory was 45 percent complete as to labor and overhead. On September 30, the ending WIP Inventory was 65 percent complete as to conversion.
Assume that Trevano Corp uses the FIFO method of process costing.
a. What proportion of work needs to be performed on the beginning inventory units to complete them?
b. What are the equivalent units of production for direct material?
c. What are the equivalent units of production for conversion?
(WA & FIFO EUP) Funtime Inc. makes small toys in a one department production process. Plastic is added at the beginning of the process; all other materials are considered indirect. The following information is available relative to September 2010 production activities:
Beginning WIP Inventory: 15,000 toys (60% complete as to labor; 75% complete as to overhead)
Started into production: plastic for 620,000 toys
Ending WIP Inventory: 25,400 toys (35% complete as to labor; 60% complete as to overhead)
a. Compute the EUP for direct material, direct labor, and overhead using weighted average process costing.
b. Compute the EUP for direct material, direct labor, and overhead using FIFO process costing.
c. Reconcile the calculations in parts (a) and (b).
(WA & FIFO EUP) Ynugai Corp. uses a process costing system to assign costs to its steel production. During March 2010, Ynugai had beginning Work in Process Inventory of 180,000 tons of steel (100 percent complete as to material and 65 percent complete as to conversion). During the month, the raw material needed to produce 3,400,000 tons of steel was started in process. At month end, 165,000 tons remained in WIP Inventory (100 percent complete as to material and 40 percent complete as to conversion).
a. Compute the total units to account for.
b. Determine how many units were started and completed.
c. Determine the equivalent units of production using the weighted average method.
d. Determine the equivalent units of production using the FIFO method.
(Cost per WA EUP) In October 2010, Room Inc.’s production was 53,600 equivalent units for direct material, 48,800 equivalent units for direct labor, and 42,000 equivalent units for overhead. During October, direct material, conversion, and overhead costs incurred were as follows:
Direct material
$158,688
Conversion
189,648
Overhead
85,200
Beginning WIP Inventory costs for October were $26,232 for direct material, $39,024 for direct labor, and $20,640 for overhead.
a. How much did Rojo Inc. spend on direct labor in October?
b. What was the October weighted average cost per equivalent unit for direct material, direct labor, and overhead?
(Cost per FIFO EUP) In October 2010, Rojo Inc.’s production was 53,600 equivalent units for direct material, 48,800 equivalent units for direct labor, and 42,000 equivalent units for overhead. During October, direct material, conversion, and overhead costs incurred were as follows:
Direct material
$158,688
Conversion
189,648
Overhead
85,200
Beginning WIP Inventory costs for October were $26,232 for direct material, $39,024 for direct labor, and $20,640 for overhead.
Assume that Rojo Inc. had 7,200 EUP for direct material in October’s beginning WIP Inventory, 8,000 EUP for direct labor, and 7,920 EUP for overhead. What was the October FIFO cost per EUP for direct material, direct labor, and overhead?
(Cost per WA & FIFO EUP) Pylonic Mfg. produces concrete garden border sections. All material is added at the beginning of processing. Production and cost information for May 2010 are as follows:
WA EUP
Direct material
160,000 sections
Direct labor
152,000 sections
Overhead
150,000 sections
FIFO EUP
Direct material
120,000 sections
Direct labor
124,000 sections
Overhead
132,000 sections
Beginning WIP Inventory costs
Direct material
$19,600
Direct labor
6,320
Overhead
10,020
Current period costs
Direct material
$54,000
Direct labor
34,720
Overhead
84,480
a. What is the total cost to account for?
b. Using weighted average process costing, what is the cost per equivalent unit for each cost component?
c. Using FIFO process costing, what is the cost per equivalent unit for each cost component?
d. How many units were in beginning inventory and at what percentage of completion was each cost component?
(WA EUP; cost per WA EUP) Waltham Mfg. makes skateboards and uses a weighted average process costing system. On May 1, 2010, the company had 400 boards in process that were 70 percent complete as to material and 85 percent complete as to conversion. During the month, 3,800 additional boards were started. On May 31, 300 boards were still in process (40 percent complete as to material and 60 percent complete as to conversion). Cost information for May 2010 is as follows:
Beginning WIP Inventory costs
Direct material
$ 4,349
Conversion
4,658
Current period costs
Direct material
60,775
Conversion
46,750
a. Calculate EUP for each cost component using the weighted average method.
b. Calculate cost per EUP for each cost component.
(FIFO EUP; cost per FIFO EUP) BeGone manufactures spray cans of insect repel lent. On August 1, 2010, the company had 9,800 units in the beginning WIP Inventory that were 100 percent complete as to canisters, 60 percent complete as to other materials, 40 percent complete as to direct labor, and 20 percent complete as to overhead. During August, BeGone started 81,500 units in the manufacturing process. Ending WIP Inventory included 4,600 units that were 100 percent complete as to canisters,40 percent complete as to other materials, 20 percent complete as to direct labor, and 10 percent complete as to overhead. Cost information for the month is as follows:
Beginning WIP Inventory
Canisters
$ 6,535
Other direct materials
6,174
Direct labor
6,431
Overhead
1,070
August costs
Canisters
61,940
Other direct materials
86,793
Direct labor
81,189
Overhead
160,176
Use the information except assume that BeGone uses FIFO process costing. Prepare a schedule showing the BeGone August 2010 computation of FIFO equivalent units of production and cost per equivalent unit.
(FIFO EUP; cost per FIFO EUP) Waltham Mfg. makes skateboards and uses a weighted average process costing system. On May 1, 2010, the company had 400 boards in process that were 70 percent complete as to material and 85 percent complete as to conversion. During the month, 3,800 additional boards were started. On May 31, 300 boards were still in process (40 percent complete as to material and 60 percent complete as to conversion). Cost information for May 2010 is as follows:
Beginning WIP Inventory costs
Direct material
$ 4,349
Conversion
4,658
Current period costs
Direct material
60,775
Conversion
46,750
Use the information except assume that Waltham Mfg. uses FIFO costing. Prepare a schedule showing the August 2010 computation of FIFO equivalent units of production and cost per equivalent unit.
(WA cost assignment) During August 2010, Berman Company’s Department Y equivalent unit product costs, computed under the weighted average method, were as follows:
Material
$2
Conversion
6
Transferred in
10
All material is introduced at the end of the process in Department Y. August’s ending Work in Process Inventory contained 4,000 units that were 40 percent complete as to con version. 20,000 units were transferred out during August to Finished Goods Inventory.
a. Compute the total costs that should be assigned to the August 31, 2010 Work in Process.
b. Compute the total cost of units transferred to finished goods.
c. Prepare the journal entry that Berman Company’s accountant should make at the end of August related to the units transferred out.
(FIFO cost assignment) In November 2010, Angerstein Co. computed its equivalent unit costs under FIFO process costing as follows:
Direct material
$29.50
Packaging
3.00
Direct labor
10.84
Overhead
7.68
Direct material and packaging are added at the start and end of processing, respectively. Beginning inventory cost was $1,026,810 and consisted of
$789,040 direct material cost for 54,000 EUP.
$91,862 direct labor cost for 16,200 EUP.
$145,908 overhead cost for 18,900 EUP.
Angerstein Co. transferred a total of 370,000 units to finished goods during November and had 12,000 units in ending WIP Inventory. The ending inventory units were 30 percent complete as to direct labor and 55 percent complete as to overhead.
a. What percentage complete were the beginning inventory units as to direct material? Packaging? Direct labor? Overhead?
b. What was the total cost of the completed beginning inventory units?
c. What was the cost of the units started and completed in November?
d. What was the cost of November’s ending inventory?
(EUP; cost per EUP; cost assignment; WA & FIFO) Found Sound Company mass produces miniature speakers for personal sound systems. The following cost information is available for June 2010:
Beginning inventory direct material cost
$ 4,133.20
Beginning inventory conversion cost
873.10
Direct material issued during June
62,928.00
Direct labor incurred during June
13,070.00
Overhead applied during June
10,356.00
On June 1, the company had 1,000 units in process, which were 60 percent complete as to material and 30 percent complete as to conversion. Found Sound started 8,400 units into process during June and had 300 units still in process on June 30.The ending WIP units were 80 percent complete as to material and 70 percent complete as to conversion.
a. Compute the unit costs for June under the weighted average method for direct material and for conversion.
b. Determine the cost transferred out for June using the weighted average method.
c. Determine the cost of June 30 ending inventory using the weighted average method.
d. Compute the unit costs for June under the FIFO method for direct material and for conversion.
e. Determine the total costs transferred to Finished Goods Inventory during June using the FIFO method.
f. Determine the cost of June 30 ending inventory using the FIFO method.
g. Prepare the entries for the direct material, direct labor, and overhead cost assigned to production during June as well as the transfer of the completed goods during June using the weighted average method.
Starbucks presented the following in its 2008 annual report:
STARBUCKS CORPORATION* Notes to Consolidated Financial Statements (in Part) Note 18 Segment Reporting (in Part) The Company’s revenue mix by product type was as follows (in millions):
28 Sep 08
30 Sep 07
1 Oct 06
Beverage
$6,663.30
64%
$6,029.10
64%
$5,043.40
65%
Food
1,511.70
15%
1,332.70
14%
1,024.30
13%
Coffee making equipment and other(1)
1,220.20
12%
1,136.60
12%
918.2
12%
Whole bean coffees
987.8
9%
913.1
10%
801
10%
Total
$10,383.00
100%
$9,411.50
100%
$7,786.90
100%
The following tables represent information by geographic area (in millions):
Fiscal Year Ended
28 Sep 08
30 Sep 07
1 Oct 06
Net revenues from external customers:
United States
$8,227.00
$7,678.90
$6,478.10
Other countries
2,156.00
1,732.60
1,308.80
Total
$10,383.00
$9,411.50
$7,786.90
No customer accounts for 10% or more of the Company’s revenues. Revenues are shown based on the geographic location of the customers. Revenues from countries other than the United States consist primarily of revenues from Canada and the UK, which together account for approximately 69% of net revenues for other countries for fiscal 2008.
Fiscal Year Ended
28 Sep 08
30 Sep 07
1 Oct 06
Long lived assets:
United States
$3,099.90
$2,990.60
$2,446.10
Other countries
824.8
667.9
453
Total
$3,924.70
$3,658.50
$2,899.10
Management evaluates the performance of its operating segments based on net revenues and operating income. The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies in Note 1. Operating income represents earnings before ‘‘Interest income and other, net,’’ ‘‘Interest expense,’’ and ‘‘Income taxes.’’ Allocations of portions of corporate overhead, interest, or income taxes to the segments are not significant. Identifiable assets by segment are those assets used in the Company’s operations in each segment. Unallocated corporate assets include cash and investments, unallocated assets of the corporate headquarters and roasting facilities, deferred taxes, and certain other intangibles.
Required
a. Comment on the vertical common size presentation for ‘‘Beverage, Food, Coffee Making Equipment and Other’’
b. 1. Prepare a horizontal common size analysis of revenue with October 1, 2006 as the base for ‘‘Beverage, Food, Coffee Making Equipment and Other’’ and ‘‘Whole Bean Coffees.’’
2. Comment on b(1).
c. For net revenues from external customers:
1. Prepare a vertical common size analysis for the United States and other countries. Use total as the base.
2. Comment on c(1).
3. Prepare a horizontal common size analysis, with October 1, 2006 as the base, for the United States and other countries.
4. Comment on c(3).
d. 1. Prepare a vertical common size analysis for long lived assets. Use total as the base.
2. Comment on d(1).
3. Prepare a horizontal common size analysis, with October 1, 2006 as the base, for long lived assets.
Yahoo* included these statements in its 2008 annual report:
YAHOO! INC. CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31,
2006
2007
2008
Revenues
Cost of revenues
$6,425,679
$6,969,274
$7,208,502
Gross profit
2,675,723
2,838,758
3,023,362
3,749,956
4,130,516
4,185,140
Operating expenses:
Sales and marketing
1,322,259
1,610,357
1,563,313
Product development
833,147
1,084,238
1,221,787
General and administrative
528,798
633,431
705,136
Amortization of intangibles
124,786
107,077
87,550
Restructuring charges, net
—
—
106,854
Goodwill impairment charge
—
—
487,537
Total operating expenses
2,808,990
3,435,103
4,172,177
Income from operations
940,966
695,413
12,963
Other income, net
157,034
154,011
82,838
Income before provision for income taxes, earnings in equity interests, and minority interests
1,098,000
849,424
95,801
Provision for income taxes
458,011
337,263
262,717
Earnings in equity interests
112,114
150,689
596,979
Minority interests in operations of consolidated subsidiaries
712
2,850
5,765
Net income
$751,391
$660,000
$424,298
Net income per share basic
$0.54
$0.49
$0.31
Net income per share diluted
$0.52
$0.47
$0.29
Shares used in per share calculation basic
1,388,741
1,338,987
1,369,476
Shares used in per share calculation diluted
1,457,686
1,405,486
1,400,101
Stock based compensation expense by function:
Cost of revenues
$6,621
$10,628
$13,813
Sales and marketing
155,084
246,472
182,826
Product development
144,807
218,207
178,091
General and administrative
118,418
97,120
63,113
Restructuring expense reversals
—
—
30,236
Total stock based compensation expense
$424,930
$572,427
$407,607
YAHOO! INC. CONSOLIDATED BALANCE SHEETS
December 31,
2007
2008
(In thousands, except par values)
ASSETS
Current assets:
Cash and cash equivalents
$1,513,930
$2,292,296
Short term marketable debt securities
487,544
1,159,691
Accounts receivable, net of allowance of $46,521 and $51,600, respectively
1,055,532
1,060,450
Prepaid expenses and other current assets
180,716
233,061
Total current assets
3,237,722
4,745,498
Long term marketable debt securities
361,998
69,986
Property and equipment, net
1,331,632
1,536,181
Goodwill
4,002,030
3,440,889
Intangible assets, net
611,497
485,860
Other long term assets
503,945
233,989
Investments in equity interests
2,180,917
3,177,445
Total assets
$12,229,741
$13,689,848
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable
$176,162
$151,897
Accrued expenses and other current liabilities
1,006,188
1,139,894
Deferred revenue
368,470
413,224
Short term debt
749,628
—
Total current liabilities
2,300,448
1,705,015
Long term deferred revenue
95,129
218,438
Capital lease and other long term liabilities
28,086
77,062
Deferred and other long term tax liabilities, net
260,993
420,372
Commitments and contingencies
—
—
Minority interests in consolidated subsidiaries
12,254
18,019
Stockholders’ equity:
Preferred stock, $0.001 par value, 10,000 shares authorized; none issued or outstanding
Common stock, $0.001 par value; 5,000,000 shares authorized; 1,534,893 and 1,600,220 shares issued, respectively, and 1,330,828 and 1,391,560 shares outstanding, respectively
1,527
1,595
Additional paid in capital
9,937,010
11,548,393
Treasury stock at cost, 204,065 and 208,660 shares, respectively
5,160,772
5,267,484
Retained earnings
4,423,864
4,848,162
Accumulated other comprehensive income
331,202
120,276
Total stockholders’ equity
9,532,831
11,250,942
Total liabilities and stockholders’ equity
$12,229,741
$13,689,848
Required
a. Compute the following for 2009 and 2008:
1. Net profit margin
2. Total asset turnover (use year end total assets)
3. Return on assets (use year end total assets)
4. Operating income margin
5. Return on operating assets (use year end operating assets).
6. Sales to fixed assets (use year end operating assets)
7. Return on total equity (use year end total equity)
8. Gross profit margin
b. Comment on the trends in (a)
1. Prepare a horizontal common size consolidated statement of operations for 2006–2008. Use 2006 as the base.
With this case, a comparison is made between three firms in different industries using net profit margin, total asset turnover, and current ratio.
Net Profit Margin
Total Asset Turnover
Current Ratio
Firm A
1.52%
3.35 times
1.11
Firm B
15.61%
.78 times
1.88
Firm C
3.52%
1.42
1.66
1. Apple Fiscal Year Ended September 26, 2009
‘‘The Company offers a range of personal computing products, mobile communication devices, and portable digital music and video players, as well as a variety of related software, services, peripherals, networking solutions, and various third party hardware and software products.’’ 10 K
2. Costco Wholesale Corporation
‘‘We operate membership warehouses based on the concept that offering our members low prices on a limited selection of nationally branded and selected private label products in a wide range of merchandise categories will produce high sales volumes and rapid inventory turnover.’’ 10 K
3. Target Corporation
‘‘Our Retail Segment includes all of our merchandising operations, including our large format general merchandise and food discount stores in the United States and our fully integrated online business. We offer both everyday essentials and fashionable, differentiated merchandise at exceptional prices.’’ 10 K
With this case, we review the profitability of several specialty retail stores. The companies reviewed and the year end dates are as follows:
1. Abercrombie & Fitch Co.
(January 31, 2009—52 week; February 2, 2008—52 week; February 3, 2007—53 week) ‘‘Abercrombie & Fitch Co.…is a specialty retailer that operates stores and websites selling casual sportswear apparel.’’ 10 K
2. Limited Brands, Inc.
(January 31, 2009—52 week; February 2, 2008—52 week; February 3, 2007—53 week) ‘‘We operate in the highly competitive specialty retail business.’’ 10 K
3. GAP, Inc.
(January 31, 2009—52 week; February 2, 2008—52 week; February 3, 2007—53 week) ‘‘We are a global specialty retailer offering clothing, accessories, and personal care products.’’
10 K
Abercrombie & Fitch
Limited Brands
GAP
Data reviewed
2009
2008
2009
2008
2009
2008
Net profit margin
7.69
12.69
2.39
6.87
6.66
5.5
Return on assets
10.05
19.76
3
9.58
12.56
10.58
Return on total equity
15.72
31.47
10.75
27.75
22.33
18.35
Required
a. Comment on the net profit margin for these companies. Consider absolute amounts and trend.
b. Comment on the return on assets for these companies. Consider absolute amounts and trend.
c. Comment on the return on total equity for these companies. Consider absolute amounts and trend.
d. Comment on the relative profitability of these companies.
With this case, we review the profitability of several restaurant companies. The restaurant companies reviewed and the year end dates are as follows:
1. Yum Brands, Inc.
(December 30, 2008; December 30, 2007)
‘‘Through the five concepts of KFC, Pizza Hut, Taco Bell, LJS and A & W (the ‘‘Concepts’’)
the company develops, operates, franchises and licenses a world system of restaurants which prepare, package and sell a menu of competitively priced food items.’’ 10 K
2. Panera Bread
(December 30, 2008; December 25, 2007)
‘‘As of December 30, 2008, Panera operated and through franchise agreements with 39 franchisee groups, 1,252 cafes.’’ 10 K
3. Starbucks
(September 28, 2008; September 30, 2007)
‘‘Starbucks Corporation was formed in 1985 and today is the world’s leading roaster and retailer of specialty coffee.’’ 10 K
Yum Brands, Inc.
Panera Bread
Starbucks
Ratio
2008
2007
2008
2007
2008
2007
Net profit margin %
8.55
8.73
5.31
5.35
1.94
6
Return on assets %
14.06
13.41
10.05
9.19
5.73
13.76
Return on total equity %
187
70.17
14.33
13.62
13.21
29.81
Required
a. Comment on the net profit margin for these companies. Consider absolute amounts and trend.
b. Comment on the return on assets for these companies. Consider absolute amounts and trend.
c. Comment on the return on total equity for these companies. Consider absolute amounts and trend.
d. Comment on the relative profitability of these companies.
1. Why is the price/earnings ratio considered a gauge of future earning power?
2. Why does a relatively new firm often have a low dividend payout ratio? Why does a firm with a substantial growth record and/or substantial growth prospects often have a low dividend payout ratio?
3. Why would an investor ever buy stock in a firm with a low dividend yield?
4. Why is book value often meaningless? What improvements to financial statements would make it more meaningful?
5. Why should an investor read the note concerning stock options? How might stock options affect profitability?
6. Why can a relatively small number of stock appreciation rights prove to be a material drain on future earnings and cash of a company?
7. Explain how outstanding stock appreciation rights could increase reported income in a particular year.
Cook Company shows the following condensed income statement information for the year ended December 31, 2009:
Income before extraordinary gain
$30,000
Plus: Extraordinary gain, net of tax expense of $2,000
5,000
Net income
$35,000
The company declared dividends of $3,000 on preferred stock and $5,000 on common stock. At the beginning of 2009, 20,000 shares of common stock were outstanding. On July 1, 2009, the company issued 1,000 additional common shares. The preferred stock is not convertible.
Required
a. Compute the earnings per share.
b. How much of the earnings per share appears to be recurring?
Preferred dividends (The preferred stock is not convertible.)
$10,000
Common shares outstanding on January 1
20,000 shares
Common stock issued on July 1 2 for 1 stock split on December 31
5,000 shares
Required
a. Compute the earnings per share for the current year.
b. Earnings per share in the prior year was $8.00. Use the earnings per share computed in (a) and present a two year earnings per share comparison for the current year and the prior year.
Smith and Jones, Inc. is primarily engaged in the worldwide production, processing, distribution, and marketing of food products. The following information is from its 2009 annual report:
2009
2008
Earnings per share
$1.08
$1.14
Cash dividends per common share
$0.80
$0.76
Market price per common share
$12.94
$15.19
Common shares outstanding
25,380,000
25,316,000
Total assets
$1,264,086,000
$1,173,924,000
Total liabilities
$823,758,000
$742,499,000
Nonredeemable preferred stock
$16,600,000
$16,600,000
Preferred dividends
$4,567,000
$930,000
Net income
$32,094,000
$31,049,000
Required
a. Based on these data, compute the following for 2009 and 2008:
1. Percentage of earnings retained
2. Price/earnings ratio
3. Dividend payout
4. Dividend yield
5. Book value per share
b. Discuss your findings from the viewpoint of a potential investor.
On December 31, 2009, Farley Camera, Inc., issues 5,000 stock appreciation rights to its president to entitle her to receive cash for the difference between the market price of its stock and a preestablished price of $20. The date of exercise is December 31, 2010, and the required service period is the entire three years. The market price fluctuates as follows: 12/31/10—$23.00; 12/31/11— $21.00; 12/31/12—$26.00. Farley Camera accrued the following compensation expense:
2010
$15,000
2011
($10,000)
2012
$25,000
Required
a. What is the executive’s main advantage of receiving stock appreciation rights over stock options?
b. In 2010, a $15,000 expense is recorded. What is the offsetting account?
c. What is the financial impact on the company of the exercise of the stock appreciation rights in 2012? How does this impact affect financial statement analysis?
In 2007 and 2008, Zoret Company reported earnings per share of $0.80 and $1.00, respectively. In 2009, Zoret Company declared a 4 for 1 stock split. For the year 2009, Zoret Company reported earnings of $0.30 per share. The appropriate earnings per share presentation for a three year comparative analysis that includes 2007, 2008, and 2009 would be
Less: Accumulated depreciation and amortization of capital leases
526,576
481,247
Property and equipment – net
1,045,240
1,018,982
Other assets
47,824
45,767
Total
$1,313,703
$1,265,030
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Accounts payable
$93,112
$93,060
Current maturities of long-term debt and other long-term obligations
8,714
8,188
Taxes withheld and accrued
29,459
32,201
Income taxes payable
—
18,066
Accrued employee compensation
46,185
48,570
Accrued employee benefits
34,241
34,926
Deferred revenues
22,618
21,162
Accrued interest expense
12,485
164
Other accrued expenses
17,905
18,332
Total current liabilities
264,719
274,669
Long-term debt
779,061
756,306
Interest rate swap liability
39,618
13,680
Other long-term obligations
83,224
53,819
Deferred income taxes
54,330
62,433
Commitments and Contingencies (Note 14)
Shareholders’ Equity:
Preferred stock – 100,000,000 shares of $.01 par value authorized; no shares issued
Common stock – 400,000,000 shares of $.01 par value authorized; 2008 – 22,325,341 shares issued and outstanding; 2007 – 23,674,175 shares issued and outstanding
223
237
Additional paid-in capital
731
—
Accumulated other comprehensive loss
-27,653
-8,988
Retained earnings
119,450
112,874
Total shareholders’ equity
92,751
104,123
Total
$1,313,703
$1,265,030
CBRL GROUP, INC CONSOLIDATED STATEMENT OF CASH FLOWS (IN PART) (In thousands, except share data)
Fiscal years ended
1-Aug-08
3-Aug-07
28-Jul-06
Net cash provided by operating activities of continuing operations
$124,510
$96,872
$174,694
Net cash used in investing activities of continuing operations
82,706
87,721
82,262
Net cash used in financing activities of continuing operations
44,459
502,309
5,385
Dividends on common stock
15,743
15,610
24,019
Required
a. 1. How many shares of common stock had been issued as of August 1, 2008?
2. How many shares of common stock were outstanding as of August 1, 2008?
3. What share number is used to compute earnings per share?
b. When computing the price/earnings ratio, should the basic or diluted earnings per share be used? Why?
c. Which earnings number would analysts put more emphasis on, income from continuing operations or net income?
d. Compute the book value for August 1, 2008, and August 3, 2007.
e. Compute the dividend payout for 2008, 2007, and 2006.
(Note: Consider computing dividend payout slightly different than the book formula).
DEERE & COMPANY* CONSOLIDATED BALANCE SHEET (IN PART) As of October 31, 2007 and 2006 (In millions of dollars, except per share amounts)
2007
2006
STOCKHOLDERS’ EQUITY
Common stock, $1 par value (authorized – 1,200,000,000* shares; issued – 536,431,204* shares in 2007 and 2006), at stated value
2,777.00
2,203.50
Common stock in treasury, 96,795,090* shares in 2007 and 81,965,080* shares in 2006, at cost
4,015.40
2,673.40
Retained earnings
9,031.70
7,886.80
Total
7,793.30
7,416.90
Retirement benefits adjustment
1,113.10
Minimum pension liability adjustment
87.6
Cumulative translation adjustment
479.4
150.3
Unrealized gain (loss) on derivatives
7.6
6.8
Unrealized gain on investments
3.8
4.8
Accumulated other comprehensive income (loss)
637.5
74.3
Total stockholders’ equity
7,155.80
7,491.20
Stock Split in Form of Dividend
On November 14, 2007, a special meeting of stockholders was held authorizing a two for one stock split effected in the form of a 100 percent stock dividend to holders of record on November 26, 2007, distributed on December 3, 2007. All share and per share data (except par value) have been adjusted to reflect the effect of the stock split for all periods presented. The number of shares of common stock issuable upon exercise of outstanding stock options, vesting of other stock awards, and the number of shares reserved for issuance under various employee benefit plans were proportionately increased in accordance with terms of the respective plans (see Notes 23 and 24).
Required
a. 1. How many shares of common stock had been issued as of October 31, 2006?
2. How many shares of common stock were outstanding as of October 31, 2006?
3. How many shares of common stock had been issued as of October 31, 2007?
4. How many shares of common stock were outstanding as of October 31, 2007?
b. Statement of Consolidated Income (in Part)
For the years ended October 31, 2006 and 2005:
Per share data
2006
2005
Basic
$6.23
$5.81
Discontinued operations
1.03
0.14
Net income
$7.26
$5.95
How will this per share data be presented on the October 31, 2007 statement?
WAL MART STORES, INC.* CONSOLIDATED BALANCE SHEETS
January 31,
(Amounts in millions except per share data)
2009
2008
Assets
Current assets:
Cash and cash equivalents
$7,275
$5,492
Receivables
3,905
3,642
Inventories
34,511
35,159
Prepaid expenses and other
3,063
2,760
Current assets of discontinued operations
195
967
Total current assets
48,949
48,020
Property and equipment, at cost:
Land
19,852
19,879
Buildings and improvements
73,810
72,141
Fixtures and equipment
29,851
28,026
Transportation equipment
2,307
2,210
Property and equipment, at cost
125,820
122,256
Less accumulated depreciation
32,964
28,531
Property and equipment, net
92,856
93,725
Property under capital lease:
Property under capital lease
5,341
5,736
Less accumulated amortization
2,544
2,594
Property under capital lease, net
2,797
3,142
Goodwill
15,260
15,879
Other assets and deferred charges
3,567
2,748
Total assets
$163,439
$163,514
Liabilities and Shareholders’ Equity
Current liabilities:
Commercial paper
$1,506
$5,040
Accounts payable
28,849
30,344
Accrued liabilities
18,112
15,725
Accrued income taxes
677
1,000
Long term debt due within one year
5,848
5,913
Obligations under capital leases due within one year
315
316
Current liabilities of discontinued operations
83
140
Total current liabilities
55,390
58,478
Long term debt
31,349
29,799
Long term obligations under capital leases
3,200
3,603
Deferred income taxes and other
6,014
5,087
Minority interest
2,191
1,939
Commitments and contingencies
Shareholders’ equity:
Preferred stock ($0.10 par value; 100 shares authorized, none issued)
Common stock ($0.10 par value, 11,000 shares authorized, 3,925 and 3,973 issued and outstanding at January 31, 2009 and January 31, 2008, respectively)
393
397
Capital in excess of par value
3,920
3,028
January 31,
(Amounts in millions except per share data)
2009
2008
Retained earnings
63,660
57,319
Accumulated other comprehensive (loss) income
2,688
3,864
Total shareholders’ equity
65,285
64,608
Total liabilities and shareholders’ equity
$163,429
$163,514
Required
a. Observe that accumulated amortization is deducted from property under capital lease. Why is
this described as amortization instead of depreciation?
b. Why do the assets under capital leases not equal the liabilities under capital leases?
SAFEWAY, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In millions, except per share amounts)
53 Weeks 2008
52 Weeks 2007
52 Weeks 2006
Sales and other revenue
$44,104.00
$42,286.00
$40,185.00
Cost of goods sold
31,589.20
30,133.10
28,604.00
Gross profit
12,514.80
12,152.90
11,581.00
Operating and administrative expense
10,662.10
10,380.80
9,981.20
Operating profit
1,852.70
1,772.10
1,599.80
Interest expense
358.7
388.9
396.1
Other income, net
10.6
20.4
36.3
Income before income taxes
1,504.60
1,403.60
1,240.00
Income taxes
539.3
515.2
369.4
Net income
$965.30
$888.40
$870.60
Basic earnings per share
$2.23
$2.02
$1.96
Diluted earnings per share
$2.21
$1.99
$1.94
Weighted average shares outstanding—basic
433.8
440.3
444.9
Weighted average shares outstanding—diluted
436.3
445.7
447.8
SAFEWAY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN PART) (In millions, except per share amounts)
Year End 2008
Year End 2007
Total current assets
$3,976.20
$4,007.50
Total assets
17,484.70
17,651.00
Total current liabilities
4,499.20
5,136.40
Total liabilities
10,698.50
10,949.20
Total stockholders’ equity
6,786.20
6,701.80
Total liabilities and stockholders’ equity
$17,484.70
$17,651.00
Required
a. For the defined benefit, noncontributory retirement plans, compare pension expense (cost) with operating revenue for 2008, 2007, and 2006. Comment.
b. For the defined benefit, noncontributory retirement plans, compare pension expense (cost) with income before income taxes for 2008, 2007, and 2006.
c. For the defined benefit, noncontributory retirement plans, compare the benefit obligations with the value of plan assets at the end of 2008 and 2007. Comment.
d. Are all of Safeway’s defined benefit, noncontributory retirement plans overfunded or underfunded? Comment.
Notes to Consolidated Financial Statements (in Part)
December 31, 2008
NOTE 1—NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (in Part)
Fair Values of Financial Instruments
At December 31, 2007 and 2008, our financial instruments included cash and cash equivalents, trade receivables, marketable securities and accounts payable. Our subordinated notes outstanding at December 31, 2007, were repaid in December 2008. The carrying amount of cash and cash equivalents, trade receivables, and accounts payable approximates fair value due to the short term maturities of these instruments. The estimated fair values of financial assets were determined based on quoted market prices at year end. The estimated fair value of the subordinated notes payable was determined based on the present value of its future cash flows using a discount rate that approximates our current borrowing rate.
NOTE 12—FAIR VALUE OF FINANCIAL INSTRUMENTS
On January 1, 2008, we adopted SFAS No. 157, ‘‘Fair Value Measurements,’’ except for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis pursuant to FSP 157 2. SFAS No. 157 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, SFAS No. 157 establishes a three tier value hierarchy, which prioritizes the inputs used in measuring fair value as follows: (Level 1) observable inputs such as quoted prices in active markets; (Level 2) inputs other than the quoted prices in active markets that are observable either directly or indirectly; and (Level 3) unobservable inputs in which there is little or no market data, which requires us to develop our own assumptions. This hierarchy requires us to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. The carrying value of cash and cash equivalents, accounts receivable, and trade payables approximates the fair value due to their short term maturities
For recognition purposes, we measure our marketable equity securities at fair value on a recurring basis, as determined using quoted prices in active markets (Level 1) and/or significant unobservable inputs (Level 3) as presented in the table below. In May 2008, we sold our remaining investments in marketable equity securities of GSSL.
For disclosure purposes only, we are required to measure the fair value of outstanding debt on a recurring basis. The fair value of our subordinated notes payable represents the net present value of discounted cash flows. Our subordinated notes payable is reported at amortized cost in accordance with SFAS No. 107, ‘‘Disclosure about Fair Value of Financial Instruments,’’ and was $6,936,000 at December 31, 2007. The fair value of our subordinated notes payable was $7,455,000 at December 31, 2007. In December 2008, we repaid the remaining principal balance of the subordinated notes payable.
Fair Value Measurements Using
Carrying Value
Quoted Prices in Active Markets (Level 1)
Significant Other Observable Inputs (Level 2)
Significant Unobservable Inputs (Level 3)
At December 31, 2007
Financial Assets:
Investment in Marketable Equity
Securities of GSSL
$4,953
$4,953
$—
$—
Marketable Equity Securities Held in
Supplemental Retirement Plan
$1,869
$1,249
$—
Marketable Equity Securities Held in Life
Insurance Contracts
$625
$625
$—
Financial liability:
Subordinated Notes Payable
$6,936
$ —
$—
At December 31, 2008
Financial Assets:
Marketable Equity Securities Held in
Supplemental Retirement Plan
$1,341
$741
$—
Marketable Equity Securities Held in Life
Insurance Contracts
$338
$338
$—
$—
The fair values of the recurring financial assets and liabilities measured using Level 3 inputs
changed during the year ended December 31, 2008 as follows (in thousands):
Marketable Equity Securities Supplemental Retirement Plan
Subordinated Notes Payable
Balance at December 31, 2007
$620
$7,455
Total Realized and Unrealized Gains or Losses
Included in Earnings or Changes in Net Assets
18
255
Currency Translation Included in Other
45
—
Comprehensive Income
Purchases, Issuances, and Settlements
7
7,200
Transfer In and / or Out of Level 3
—
—
Balance at December 31, 2008
$600
$ —
On a nonrecurring basis, we use fair value measures when analyzing asset impairment. Long lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If it is determined that such indicators are present and the review indicates that the assets will not be fully recoverable, based on undiscounted estimated cash flows over the remaining amortization periods, their carrying values are reduced to estimated fair value. During 2008, we recorded an impairment charge of $253,000 related to developed technologies. Refer to Note 4—Goodwill and Other Intangible Assets for further discussion. Goodwill and indefinite lived intangibles are tested for impairment annually or whenever events or circumstances make it more likely than not that impairment may have occurred. During 2008, we recorded an impairment charge of $9,698,000 related to trademarks and tradenames. Refer to Note 4—Goodwill and Other Intangible Assets for further discussion.
Required
a. The carrying amount of cash and cash equivalents, trade receivables and accounts payable approximates fair value. Why?
b. December 31, 2007
1. Why are investments in marketable equity securities of GSSL classified as fair value measurements under Level 1?
c. December 31, 2007 and December 31, 2008
i. Why are marketable equity securities held in supplemental retirement plans partially classified under Level 1 and partially under Level 3?
ii. Why are marketable equity securities held in life insurance contracts classified under Level 1?
d. During 2008, an impairment charge of $253,000 was made related to developed technologies. Why?
In this case, we review the debt of several specialty retail stores. The companies reviewed and the year end dates are as follows:
1. Abercrombie & Fitch Co.
(January 31, 2009—52 week; February 2, 2008—52 week; February 3, 2007—53 week) ‘‘Abercrombie * Fitch Co… is a specialty retailer that operates stores and websites selling casual sportswear apparel.’’ 10 K
2. Limited Brands, Inc.
(January 31, 2009—52 week; February 2, 2008—52 week; February 3, 2007—53 week) ‘‘We operate in the highly competitive specialty retail business.’’ 10 K
3. Gap Inc.
(January 31, 2009—52 week; February 2, 2008—52 week; February 3, 2007—53 week) ‘‘We are a global specialty retailer offering clothing, accessories, and personal care products.’’ 10 K
Abercrombie & Fitch
Limited Brands
GAP
2009
2008
2009
2008
2009
2008
Times interest earned
XX
3.42
8.05
176.11
39.78
Fixed charge coverage (times per year)
XX
XX
2.8
5
5.15
4.48
Debt ratio (%)
35.2
36.97
73.12
70.16
42
45.47
Debt/equity ratio (%)
54.32
58.66
272.04
235.15
72.42
83.39
Debt to tangible net worth ratio (%)
54.32 *
58.65*
75.3
83.38
Required
a. Comment on the relative times interest earned between the companies.
b. Comment on the relative fixed charge coverage for each company.
c. Comment on the relative times interest earned vs. the fixed charge coverage. Why is the times interest earned materially higher than the fixed charge coverage?
d. Why is the debt/equity materially more than the debt ratio?
e. Considering the debt ratio, comment on the relative debt position of these companies.
f. Why is the debt to tangible net worth usually higher than the debt/equity ratio?
In this case, we review the debt of several restaurant companies. The restaurant companies reviewed and the year end dates are as follows:
1. Yum Brands, Inc.
(December 30, 2008; December 30, 2007)
‘‘Through the five concepts of KFC, Pizza Hut, Taco Bell, LJS, and A & W (the ‘‘Concepts’’) the company develops, operates, franchises and licenses a world system of restaurants which prepare, package and sell a menu of competitively priced food items.’’ 10 K
2. Panera Bread
(December 30, 2008; December 25, 2007)
‘‘As of December 30, 2008, Panera operated and through franchise agreements with 39 franchisee groups, 1,252 cafes.’’ 10 K
3. Starbucks
(September 28, 2008; September 30, 2007)
‘‘Starbucks Corporation was formed in 1985 and today is the world’s leading roaster and retailer of specialty coffee.’’ 10 K
Yum Brands, Inc.
Panera Bread
Starbucks
2008
2007
2008
2007
2008
2007
Times interest earned
6.66
8.17
64.66
185.04
6.59
23.43
Fixed charge coverage (times per year)
3.9
4.39
4.92
5.05
2.1
4.71
Debt ratio (%)
101.65
84.15
26.52
36.15
56.09
57.26
Debt/equity ratio (%)
Negative
531.08
36.1
56.61
127.73
133.96
Debt to tangible net worth ratio (%)
Negative
1,007.96
46.15
74.9
147.45
151
Required
a. Comment on the relative times interest earned between the companies.
b. Comment on the relative fixed charge coverage for each company.
c. Comment on the relative times interest earned vs. the fixed charge coverage. Why is the times interest earned materially higher than the fixed charge coverage?
d. Why is the debt/equity materially more than the debt ratio?
e. Considering the debt ratio, comment on the relative debt position of these companies.
f. Why is the debt to tangible net worth usually higher than the debt/equity ratio?
1. What is return on investment? What are some of the types of measures for return on investment? Why is the following ratio preferred?
Net Income Before Noncontrolling Interest and nonrecurring Items + [(Interest expense) X (1 Tax Rate )] / Average (Long Term Debt + Equity)
Why is the interest multiplied by (1 Tax Rate)?
2. G. Herrich Company and Thomas, Inc., are department stores. For the current year, they reported a net income after tax of $400,000 and $600,000, respectively. Is Thomas, Inc., a more profitable company than G. Herrich Company? Discuss.
3. Since interim reports are not audited, they are not meaningful. Comment.
4. Speculate on why accounting standards do not mandate full financial statements in interim reports.
5. Why may comprehensive income fluctuate substantially more than net income?
6. Why can pro forma financial information be misleading?
Ahl Enterprise lists the following data for 2009 and 2008:
2009
2008
Net income
52,500
40,000
Net sales
1,050,000
1,000,000
Average total assets
230,000
200,000
Average common equity
170,000
160,000
Required
Calculate the net profit margin, return on assets, total asset turnover, and return on common equity for both years. Comment on the results. (For return on assets and total asset turnover, use end of year total assets; for return on common equity, use end of year common equity.)
Transactions affect various financial statement amounts.
Net Profit
Retained Earnings
Total Stockholders’ Equity
a. A stock dividend is declared and paid.
b. Merchandise is purchased on credit.
c. Marketable securities are sold above cost.
d. Accounts receivable are collected.
e. A cash dividend is declared and paid.
f. Treasury stock is purchased and recorded at cost.
g. Treasury stock is sold above cost.
h. Common stock is sold.
i. A fixed asset is sold for less than book value.
j. Bonds are converted into common stock.
Required
Indicate the effects of the previous transactions on each of the following: net profit, retained earnings, total stockholders’ equity. Use + to indicate an increase, to indicate a decrease, and 0 to indicate no effect.
Consecutive five year balance sheets and income statements of Mary Lou Szabo Corporation are as follows:
Mary Lou Szabo Corporation Balance Sheets December 31, 2005, through December 31, 2009
(Dollars in thousands)
2009
2008
2007
2006
2005
Assets
Current assets:
Cash
$24,000
$25,000
$26,000
$24,000
$26,000
Accounts receivable, net
120,000
122,000
128,000
129,000
130,000
Inventories
135,000
138,000
141,000
140,000
137,000
Total current assets
279,000
285,000
295,000
293,000
293,000
Property, plant, and equipment, net
500,000
491,000
485,000
479,000
470,000
Goodwill
80,000
85,000
90,000
95,000
100,000
Total assets
$859,000
$861,000
$870,000
$867,000
$863,000
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable
$180,000
$181,000
$181,500
$183,000
$184,000
Income taxes
14,000
14,500
14,000
12,000
12,500
Total current liabilities
194,000
195,500
195,500
195,000
196,500
Long term debt
65,000
67,500
79,500
82,000
107,500
Redeemable preferred stock
80,000
80,000
80,000
80,000
—
Total liabilities
339,000
343,000
355,000
357,000
304,000
Stockholders’ equity:
Preferred stock
70,000
70,000
70,000
70,000
120,000
Common stock
350,000
350,000
350,000
350,000
350,000
Paid in capital in excess of par, common stock
15,000
15,000
15,000
15,000
15,000
Retained earnings
85,000
83,000
80,000
75,000
74,000
Total stockholders’ equity
520,000
518,000
515,000
510,000
559,000
Total liabilities and stockholders’ equity
$859,000
$861,000
$870,000
$867,000
$863,000
Mary Lou Szabo Corporation Statement of Earnings Years Ended December 31, 2005–2009
(Dollars in thousands)
2009
2008
2007
2006
2005
Net sales
$980,000
960,000
$940,000
$900,000
$880,000
Cost of goods sold
625,000
616,000
607,000
580,000
566,000
Gross profit
355,000
344,000
333,000
320,000
314,000
Selling and administrative expense
240,000
239,000
238,000
239,000
235,000
Interest expense
6,500
6,700
8,000
8,100
11,000
Earnings from continuing operations before income taxes
108,500
98,300
87,000
72,900
68,000
Income taxes
35,800
33,400
29,200
21,700
23,100
Earnings from continuing operations
72,700
64,900
57,800
51,200
44,900
Extraordinary loss, net of taxes
—
—
—
—
30,000
Net earnings
$72,700
$64,900
$57,800
$51,200
$14,900
Earnings (loss) per share:
Continuing operations
$2.00
$1.80
$1.62
$1.46
$1.28
Extraordinary loss
—
—
—
—
0.85
Net earnings per share
$2.00
$1.80
$1.62
$1.46
$0.43
Redeemable preferred stock
Preferred stock
2006–2009 $6,400
2006–2009
$6,300
2005
10,800
Required
a. Compute the following for the years ended December 31, 2005–2009:
1. Net profit margin
2. Total asset turnover
3. Return on assets
4. DuPont return on assets
5. Operating income margin
6. Operating asset turnover
7. Return on operating assets
8. DuPont return on operating assets
9. Sales to fixed assets
10. Return on investment
11. Return on total equity
12. Return on common equity
13. Gross profit margin
Note: For ratios that call for using average balance sheet figures, compute the rate using average balance sheet figures and year end balance sheet figures.
b. Briefly comment on profitability and trends indicated in profitability. Also comment on the difference in results between using the average balance sheet figures and year end figures.
The Bishop Company has a balance in the warranty obligation account of $400,000. An analysis of the products sold under warranty indicates that a balance of $900,000 should be adequate for this year end.
The president of Bishop Company directs that the balance be adjusted to $600,000. If more is needed, it will be adjusted next quarter. The president indicates that there is not adequate liquidity currently to pay more than $600,000.
Required
a. 1. Adjusting to $600,000 will add how much to expense for the current year?
2. Adjusting to $900,000 will add how much to expense for the current year?
b. If the balance in the warranty obligation account is not adequate, will this prevent subsequent payments? Comment.
c. Comment on the ethics of not providing a balance that is reasonably close to what the analysis indicates.
John Dearden and his wife, Patricia, have been taking a vacation to Stowe, Vermont, each summer. They like the area very much and would like to retire someday in this vicinity. While in Stowe during the summer, they notice a ‘‘for sale’’ sign in front of a self service station. John is 5 and is no longer satisfied with commuting to work in New York City. He decides to inquire about the asking price of the station. He is aware that Stowe is considered a good vacation area during the entire year, especially when the ski season is in progress.
On inquiry, John determines that the asking price of the station is $70,000, which includes two pumps, a small building, and 1/8 acre of land.
John asks to see some financial statements and is shown profit and loss statements for 2009 and 2008 that have been prepared for tax purposes by a local accountant.
JEFF’S SELF SERVICE STATION STATEMENT OF EARNINGS For the Years Ended December 31, 2009 and 2008
2009
2008
Revenue
$185,060
$175,180
Expenses:
Cost of goods sold
160,180
153,280
Depreciation (a)
1,000
1,000
Real estate and property taxes
1,100
1,050
Repairs and maintenance
1,470
1,200
Other expenses
680
725
Total expenses
164,430
157,255
Profit
$20,630
$17,925
(a) Building and equipment cost
$30,000
Original estimated life
30 years
Depreciation per year
$1,000
John is also given an appraiser’s report on the property. The land is appraised at $50,000, and the equipment and building are valued at $20,000. The equipment and building are estimated to have a useful life of 10 years.
The station has been operated by Jeff Szabo without additional help. He estimates that if help were hired to operate the station, it would cost $10,000 per year. John anticipates that he will be able to operate the station without additional help. John intends to incorporate. The anticipated tax rate is 50%.
Required
a. Determine the indicated return on investment if John Dearden purchases the station. Include only financial data that will be recorded on the books. Consider 2009 and 2008 to be representative years for revenue and expenses.
b. Determine the indicated return on investment if help were hired to operate the station.
c. Why is there a difference between the rates of return in (a) and (b)? Discuss.
d. Determine the cash flow for 2010 if John serves as the manager and 2010 turns out to be the same as 2009. Do not include the cost of the hired help. No inventory is on hand at the date of purchase, but an inventory of $10,000 is on hand at the end of the year. There are no receivables or liabilities.
e. Indicate some other considerations that should be analyzed.
The cash account for Cabrillo Co. at March 1, 2008, indicated a balance of $10,676.67. During March, the total cash deposited was $39,146.38, and checks written totaled $42,918.40. The bank statement indicated a balance of $10,960.06 on March 31. Comparing the bank statement, the canceled checks, and the accompanying memoranda with the records revealed the following reconciling items:
a. Checks outstanding totaled $11,008.25.
b. A deposit of $8,773.34, representing receipts of March 31, had been made too late to appear on the bank statement.
c. The bank had collected for Cabrillo Co. $3,710 on a note left for collection. The face of the note was $3,500.
d. A check for $380 returned with the statement had been incorrectly charged by the bank as $830.
e. A check for $419 returned with the statement had been recorded by Cabrillo Co. as $149. The check was for the payment of an obligation to Graven Co. on account.
f. Bank service charges for March amounted to $40.
g. A check for $1,129.50 from Kane Miller Co. was returned by the bank because of insufficient funds.
Instructions
1. Prepare a bank reconciliation as of March 31.
2. Journalize the necessary entries. The accounts have not been closed.
Pacific Furniture Company deposits all cash receipts each Wednesday and Friday in a night depository, after banking hours. The data required to reconcile the bank statement as of June 30 have been taken from various documents and records and are reproduced as follows. The sources of the data are printed in capital letters. All checks were written for payments on account.
JUNE BANK STATEMENT:
MEMBER FDIC
AMERICAN NATIONAL BANK
ACCOUNT NUMBER
OF DETROIT
FROM 6/01/20–
TO 6/30/20–
DETROIT, MI 48201 2500
(313)933 8547
BALANCE
9,447.20
9
DEPOSITS
8,691.77
20
WITHDRAWALS
7,345.91
PACIFIC FURNITURE COMPANY
4
OTHER DEBITS AND CREDITS
2,298.70CR
NEW BALANCE
13,091.76
CHECKS AND OTHER DEBITS
DEPOSITS
DATE
BALANCE
No.731
162.15
No.738
251.40
690.25
6/01
9,723.90
No.739
60.55
No.740
237.50
1,080.50
6/02
10,506.35
No.741
495.15
No.742
501.90
854.17
6/04
10,363.47
No.743
671.30
No.744
506.88
840.50
6/09
10,025.79
No.745
117.25
No.746
298.66
MS 2,500.00
6/09
12,109.88
No.748
450.90
No.749
640.13
MS 125.00
6/09
11,143.85
No.750
276.77
No.751
299.37
896.61
6/11
11,464.32
No.752
537.01
No.753
380.95
882.95
6/16
11,429.31
No.754
449.75
No.756
113.95
1,606.74
6/18
12,472.35
No.757
407.95
No.760
486.39
897.34
6/23
12,475.35
942.71
6/25
13,418.06
NSF
291.90
6/28
13,126.16
SC
34.40
6/30
13,091.76
EC –– ERROR CORRECTION
OD –– OVERDRAFT
MS –– MISCELLANEOUS
PS –– PAYMENT STOPPED
NSF –– NOT SUFFICIENT FUNDS
SC –– SERVICE CHARGE
THE RECONCILEMENT OF THIS STATEMENT WITH YOUR RECORDS IS ESSENTIAL. ANY ERROR OR EXCEPTION SHOULD BE REPORTED IMMEDIATELY.
CASH ACCOUNT:
Balance as of June 1
$9,317.40
CASH RECEIPTS FOR MONTH OF JUNE
$9,565.31
DUPLICATE DEPOSIT TICKETS:
Date and amount of each deposit in June:
Date
Amount
Date
Amount
Date
Amount
June 1
$1,080.50
June 10
$ 896.61
June 22
$ 897.34
3
854.17
15
882.95
24
942.71
8
840.50
17
1,660.47
30
1,510.06
CHECKS WRITTEN:
Number and amount of each check issued in June:
Check No.
Amount
Check No.
Amount
Check No.
Amount
740
$237.50
747
Void
754
$ 449.75
741
495.15
748
$450.90
755
272.75
742
501.90
749
640.31
756
113.95
743
671.30
750
276.77
757
407.95
744
506.88
751
299.37
758
259.60
745
117.25
752
537.01
759
901.50
746
298.66
753
380.95
760
486.39
Total amount of checks issued in June
$8,305.84
BANK RECONCILIATION FOR PRECEDING MONTH:
Pacific Furniture Company Bank Reconciliation May 31, 20—
Cash balance according to bank statement
$ 9,447.20
Add deposit for May 31, not recorded by bank
690.25
$10,137.45
$162.15
345.95
251.40
60.55
820.05
$ 9,317.40
$ 9,352.50
35.10
$ 9,317.40
Instructions
1. Prepare a bank reconciliation as of June 30. If errors in recording deposits or checks are discovered, assume that the errors were made by the company. Assume that all deposits are from cash sales. All checks are written to satisfy accounts payable.
2. Journalize the necessary entries. The accounts have not been closed.
3. What is the amount of Cash that should appear on the balance sheet as of June 30?
4. Assume that a canceled check for $390 has been incorrectly recorded by the bank as $930. Briefly explain how the error would be included in a bank reconciliation and how it should be corrected.
The following procedures were recently installed by The Insideout Company:
a. All sales are rung up on the cash register, and a receipt is given to the customer. All sales are recorded on a record locked inside the cash register.
b. Vouchers and all supporting documents are perforated with a PAID designation after being paid by the treasurer.
c. Checks received through the mail are given daily to the accounts receivable clerk for recording collections on account and for depositing in the bank.
d. At the end of a shift, each cashier counts the cash in his or her cash register, unlocks the cash register record, and compares the amount of cash with the amount on the record to determine cash shortages and overages.
e. Each cashier is assigned a separate cash register drawer to which no other cashier has access.
f. Disbursements are made from the petty cash fund only after a petty cash receipt has been completed and signed by the payee.
g. The bank reconciliation is prepared by the accountant.
Instructions
Indicate whether each of the procedures of internal control over cash represents (1) a strength or (2) a weakness. For each weakness, indicate why it exists.
The cash account for Turbocharged Systems at February 29, 2008, indicated a balance of $8,608.13. The bank statement indicated a balance of $17,877.63 on February 29, 2008. Comparing the bank statement and the accompanying canceled checks and memoranda with the records reveals the following reconciling items:
a. Checks outstanding totaled $9,652.40.
b. A deposit of $11,322.90, representing receipts of February 29, had been made too late to appear on the bank statement.
c. The bank had collected $10,250 on a note left for collection. The face of the note was $10,000.
d. A check for $2,380 returned with the statement had been incorrectly recorded by Turbocharged Systems as $2,830. The check was for the payment of an obligation to Yanni Co. for the purchase of office supplies on account.
e. A check drawn for $960 had been incorrectly charged by the bank as $690.
f. Bank service charges for February amounted to $30.
Instructions
1. Prepare a bank reconciliation.
2. Journalize the necessary entries. The accounts have not been closed.
The cash account for Black Diamond Sports Co. on November 1, 2008, indicated a balance of $23,326.69. During November, the total cash deposited was $118,125.41, and checks written totaled $115,650.10. The bank statement indicated a balance of $24,226.75 on November 30, 2008. Comparing the bank statement, the canceled checks, and the accompanying memoranda with the records revealed the following reconciling items:
a. Checks outstanding totaled $12,673.40.
b. A deposit of $18,332.15, representing receipts of November 30, had been made too late to appear on the bank statement.
c. A check for $850 had been incorrectly charged by the bank as $580.
d. A check for $39.30 returned with the statement had been recorded by Black Diamond Sports Co. as $393.00. The check was for the payment of an obligation to Locke & Son on account.
e. The bank had collected for Black Diamond Sports Co. $4,590 on a note left for collection. The face of the note was $4,500.
f. Bank service charges for November amounted to $50.
g. A check for $1,080.20 from Kalina Co. was returned by the bank because of insufficient funds.
Instructions
1. Prepare a bank reconciliation as of November 30.
2. Journalize the necessary entries. The accounts have not been closed.
Vintage Interiors deposits all cash receipts each Wednesday and Friday in a night depository, after banking hours. The data required to reconcile the bank statement as of July 31 have been taken from various documents and records and are reproduced as follows. The sources of the data are printed in capital letters. All checks were written for payments on account.
BANK RECONCILIATION FOR PRECEDING MONTH (DATED JUNE 30):
Cash balance according to bank statement
$ 9,422.80
Add deposit of June 30, not recorded by bank
780.80
$10,203.60
Deduct outstanding checks:
No. 580
$310.10
No. 602
85.50
No. 612
92.50
No. 613
137.50
625.60
Adjusted balance
$ 9,578.00
Cash balance according to company’s records
$ 9,605.70
Deduct service charges
27.70
Adjusted balance
$ 9,578.00
CASH ACCOUNT:
Balance as of July 1
$9,578.00
CHECKS WRITTEN:
Number and amount of each check issued in July:
Check No.
Amount
Check No.
Amount
Check No.
Amount
614
$243.50
621
$309.50
628
$ 837.70
615
350.10
622
Void
629
329.90
616
279.90
623
Void
630
882.80
617
395.50
624
707.01
631
1,081.56
618
435.40
625
518.63
632
62.40
619
320.10
626
550.03
633
310.08
620
238.87
627
318.73
634
503.30
Total amount of checks issued in July
$8,675.01
JUNE BANK STATEMENT:
MEMBER FDIC
AMERICAN NATIONAL BANK
ACCOUNT NUMBER
OF DETROIT
FROM 7/01/20–
TO 7/31/20–
DETROIT, MI 48201-2500
(313)933-8547
BALANCE
9,422.80
9
DEPOSITS
6,086.35
20
WITHDRAWALS
7,514.11
VINTAGE INTERIORS
4
OTHER DEBITS AND CREDITS
5,150.50CR
NEW BALANCE
13,145.54
CHECKS AND OTHER DEBITS
DEPOSITS
DATE
BALANCE
No.580
310.10
No.612
92.50
780.80
07/01
9,801.00
No.613
137.50
No.614
243.50
569.50
07/03
9,989.50
No.615
350.10
No.616
279.90
701.80
07/06
10,061.30
No.617
395.50
No.618
435.40
819.24
07/11
10,049.64
No.619
320.10
No.620
238.87
580.70
07/13
10,071.37
No.621
309.50
No.624
707.01
MS 5,000.00
07/14
14,054.86
No.625
158.63
No.626
550.03
MS 400.00
07/14
13,746.20
No.627
318.73
No.629
329.90
600.10
07/17
13,697.67
No.630
882.80
No.631
1,081.56
NSF 225.40
07/20
11,507.91
No.632
62.40
No.633
310.08
701.26
07/21
11,836.69
731.45
07/24
12,568.14
601.50
07/28
13,169.64
SC
24.10
07/31
13,145.54
EC –– ERROR CORRECTION
OD –– OVERDRAFT
MS –– MISCELLANEOUS
PS –– PAYMENT STOPPED
NSF –– NOT SUFFICIENT FUNDS
SC –– SERVICE CHARGE
THE RECONCILEMENT OF THIS STATEMENT WITH YOUR RECORDS IS ESSENTIAL. ANY ERROR OR EXCEPTION SHOULD BE REPORTED IMMEDIATELY.
CASH RECEIPTS FOR MONTH OF JULY
6,230.10
DUPLICATE DEPOSIT TICKETS:
Date and amount of each deposit in July:
Date
Amount
Date
Amount
Date
Amount
July 2
$569.50
July 12
$580.70
July 23
$731.45
5
701.80
16
600.10
26
601.00
9
819.24
19
701.26
31
925.05
Instructions
1. Prepare a bank reconciliation as of July 31. If errors in recording deposits or checks are discovered, assume that the errors were made by the company. Assume that all deposits are from cash sales. All checks are written to satisfy accounts payable.
2. Journalize the necessary entries. The accounts have not been closed.
3. What is the amount of Cash that should appear on the balance sheet as of July 31?
4. Assume that a canceled check for $2,680 has been incorrectly recorded by the bank as $6,280. Briefly explain how the error would be included in a bank reconciliation and how it should be corrected.
The following is an excerpt from a conversation between two sales clerks, Fred Loya and Steph Gillespie. Both Fred and Steph are employed by Wireless Electronics, a locally owned and operated electronics retail store.
Fred: Did you hear the news?
Steph: What news?
Fred: Alice and John were both arrested this morning.
Steph: What? Arrested? You’re putting me on!
Fred: No, really! The police arrested them first thing this morning. Put them in handcuffs, read them their rights—the whole works. It was unreal!
Steph: What did they do?
Fred: Well, apparently they were filling out merchandise refund forms for fictitious customers and then taking the cash.
Steph: I guess I never thought of that. How did they catch them?
Fred: The store manager noticed that returns were twice that of last year and seemed to be increasing. When he confronted Alice, she became flustered and admitted to taking the cash, apparently over $5,000 in just three months. They’re going over the last six months’ transactions to try to determine how much John stole. He apparently started stealing first. Suggest appropriate control procedures that would have prevented or detected the theft of cash.
The following is an excerpt from a conversation between the store manager of Trader Sam’s Grocery Stores, Jennings Maloy, and Sam Burley, president of Trader Sam’s Grocery Stores.
Sam: Jennings, I’m concerned about this new scanning system.
Jennings: What’s the problem?
Sam: Well, how do we know the clerks are ringing up all the merchandise?
Jennings: That’s one of the strong points about the system. The scanner automatically rings up each item, based on its bar code. We update the prices daily, so we’re sure that the sale is rung up for the right price.
Sam: That’s not my concern. What keeps a clerk from pretending to scan items and then simply not charging his friends? If his friends were buying 10 15 items, it would be easy for the clerk to pass through several items with his finger over the bar code or just pass the merchandise through the scanner with the wrong side showing. It would look normal for anyone observing. In the old days, we at least could hear the cash register ringing up each sale.
Jennings: I see your point.
Suggest ways that Trader Sam’s Grocery Stores could prevent or detect the theft of merchandise as described.
Pete Harsh and Sara Alper are both cash register clerks for Farmers’ Markets. Gina Majed is the store manager for Farmers’ Markets. The following is an excerpt of a conversation between Pete and Sara:
Pete: Sara, how long have you been working for Farmers’ Markets?
Sara: Almost five years this July. You just started two weeks ago . . . right?
Pete: Yes. Do you mind if I ask you a question?
Sara: No, go ahead.
Pete: What I want to know is, have they always had this rule that if your cash register is short at the end of the day, you have to make up the shortage out of your own pocket?
Sara: Yes, as long as I’ve been working here.
Pete: Well, it’s the pits. Last week I had to pay in almost $50.
Sara: It’s not that big a deal. I just make sure that I’m not short at the end of the day.
Pete: How do you do that?
Sara: I just short change a few customers early in the day. There are a few jerks that deserve it anyway. Most of the time, their attention is elsewhere and they don’t think to check their change.
Pete: What happens if you’re over at the end of the day?
Sara: Majed lets me keep it as long as it doesn’t get to be too large. I’ve not been short in over a year. I usually clear about $50 to $80 extra per day.
Discuss this case from the viewpoint of proper controls and professional behavior.
The records of Filippi’s Company indicate a March 31 cash balance of $10,806.05, which includes undeposited receipts for March 30 and 31. The cash balance on the bank statement as of March 31 is $7,004.95. This balance includes a note of $3,000 plus $120 interest collected by the bank but not recorded in the journal. Checks outstanding on March 31 were as follows: No. 670, $1,129.16; No. 679, $830; No. 690, $525.90; No. 2148, $127.40; No. 2149, $520; and No. 2151, $851.50. On March 3, the cashier resigned, effective at the end of the month. Before leaving on March 31, the cashier prepared the following bank reconciliation:
Cash balance per books, March 31
$10,806.05
Add outstanding checks:
$127.40
No. 2148
2149
520.00
2151
851.50
1,198.90
$12,004.95
Less undeposited receipts
5,000.00
Cash balance per bank, March 31
$ 7,004.95
Deduct unrecorded note with interest
3,120.00
True cash, March 31
$ 3,884.95
Calculator Tape of Outstanding Checks:
0.00 *
127.40 +
520.00 +
851.50 +
1,198.90 *
Subsequently, the owner of Filippi’s Company discovered that the cashier had stolen an unknown amount of undeposited receipts, leaving only $5,000 to be deposited on March 31. The owner, a close family friend, has asked your help in determining the amount that the former cashier has stolen.
1. Determine the amount the cashier stole from Filippi’s. Show your computations in good form.
2. How did the cashier attempt to conceal the theft?
3. a. Identify two major weaknesses in internal controls, which allowed the cashier to steal the undeposited cash receipts.
b. Recommend improvements in internal controls, so that similar types of thefts of undeposited cash receipts can be prevented.
OccuLogix, Inc., provides treatments for eye diseases, including age related macular degeneration (AMD). The company’s treatment system, called the RHEO system, consists of an Octonova pump and disposable treatment sets that improve microcirculation in the eye by filtering high molecular weight proteins and other macromolecules from the patient’s plasma. OccuLogix reported the following data (in thousands) for the years ending December 31, 2005, 2004, and 2003:
2005
2004
2003
Cash as of December 31*
$41,268
$60,040
$ 1,239
Net cash flows from operating activities
(18,710)
(5,382)
(2,375)
*Includes cash equivalents and short term investments.
1. Determine the monthly cash expenses for 2005, 2004, and 2003. Round to one decimal place.
2. Determine the ratio of cash to monthly expenses as of December 31, 2005, 2004, and 2003. Round to one decimal place.
3. Based upon (1) and (2), comment on OccuLogix’s ratio of cash to monthly operating expenses for 2005, 2004, and 2003.
Acusphere, Inc., is a specialty pharmaceutical company that develops new drugs and improved formulations of existing drugs using its proprietary microparticle technology. Currently, the company has three products in development in the areas of cardiology, oncology, and asthma. Acusphere reported the following data (in thousands) for the years ending December 31, 2005, 2004, and 2003.
2005
2004
2003
Cash as of December 31*
$ 51,112
$ 45,180
$ 54,562
Net cash flows from operating activities
(30,683)
(19,319)
(15,507)
*Includes cash equivalents and short term investments.
1. Determine the monthly cash expenses for 2005, 2004, and 2003. Round to one decimal place.
2. Determine the ratio of cash to monthly expenses as of December 31, 2005, 2004, and 2003. Round to one decimal place.
3. Based upon (1) and (2), comment on Acusphere’s ratio of cash to monthly operating
Ditzler Company, a construction supply company, uses the allowance method of accounting for uncollectible accounts receivable. Selected transactions completed by Ditzler Company are as follows:
Feb. 1
Sold merchandise on account to Ames Co., $8,000. The cost of the merchandise
sold was $4,500.
Mar. 15
Accepted a 60 day, 12% note for $8,000 from Ames Co. on account.
Apr. 9
Wrote off a $2,500 account from Dorset Co. as uncollectible.
21
Loaned $7,500 cash to Jill Klein, receiving a 90 day, 14% note.
May 14
Received the interest due from Ames Co. and a new 90 day, 14% note as a
renewal of the loan. (Record both the debit and the credit to the notes receivable
account.)
June 13
Reinstated the account of Dorset Co., written off on April 9, and received
$2,500 in full payment.
July 20
Jill Klein dishonored her note.
Aug. 12
Received from Ames Co. the amount due on its note of May 14.
19
Received from Jill Klein the amount owed on the dishonored note, plus interest
for 30 days at 15%, computed on the maturity value of the note.
Dec. 16
Accepted a 60 day, 12% note for $12,000 from Global Company on account.
31
It is estimated that 3% of the credit sales of $1,375,000 for the year ended
December 31 will be uncollectible.
Instructions
1. Journalize the transactions.
2. Journalize the adjusting entry to record the accrued interest on December 31 on the Global Company note.
After the accounts are adjusted and closed at the end of the fiscal year, Accounts Receivable has a balance of $783,150 and Allowance for Doubtful Accounts has a balance of $41,694. Describe how the accounts receivable and the allowance for doubtful accounts are reported on the balance sheet.
A firm has consistently adjusted its allowance account at the end of the fiscal year by adding a fixed percent of the period’s net sales on account. After five years, the balance in Allowance for Doubtful Accounts has become very large in relationship to the balance in Accounts Receivable. Give two possible explanations.
Which of the two methods of estimating uncollectibles provides for the most accurate estimate of the current net realizable value of the receivables?
For a business, what are the advantages of a note receivable in comparison to an account receivable?
Mattel, Inc. designs, manufactures, and markets toy products worldwide. Mattel’s toys include Barbie™ fashion dolls and accessories, Hot Wheels™, and Fisher Price brands. For a recent year, Mattel reported the following net cash flows from operating activities (in thousands):
First quarter ending March 31, 2005
$(374,933)
Second quarter ending June 30, 2005
(551,080)
Third quarter ending September 30, 2005
(629,006)
Year ending December 31, 2005
466,677
Explain how Mattel can report negative net cash flows from operating activities during the first three quarters yet report net positive cash flows on December 31.
Delta Air Lines is one of the major airlines in the United States and the world. It provides passengers and cargo services for over 200 domestic U.S. cities as well as 70 international cities. It operates a fleet of over 800 aircraft and is headquartered in Atlanta, Georgia. Delta reported the following financial data (in millions) for the year ended December 31, 2004:
Net cash flows from operating activities
$(1,123)
Cash, December 31, 2004
1,811
a. Determine the monthly cash expenses. Round to one decimal place.
b. Determine the ratio of cash to monthly expenses. Round to one decimal place.
c. Based upon your analysis, do you believe that Delta will remain in business?
The following procedures were recently installed by Sacha’s Company:
a. The accounts payable clerk prepares a voucher for each disbursement. The voucher along with the supporting documentation is forwarded to the treasurer’s office for approval.
b. After necessary approvals have been obtained for the payment of a voucher, the treasurer signs and mails the check. The treasurer then stamps the voucher and supporting documentation as paid and returns the voucher and supporting documentation to the accounts payable clerk for filing.
c. Along with petty cash expense receipts for postage, office supplies, etc., several postdated employee checks are in the petty cash fund.
d. At the end of the day, cash register clerks are required to use their own funds to make up any cash shortages in their registers.
e. All mail is opened by the mail clerk, who forwards all cash remittances to the cashier. The cashier prepares a listing of the cash receipts and forwards a copy of the list to the accounts receivable clerk for recording in the accounts.
f. At the end of each day, any deposited cash receipts are placed in the bank’s night depository.
g. At the end of each day, an accounting clerk compares the duplicate copy of the daily cash deposit slip with the deposit receipt obtained from the bank.
h. The bank reconciliation is prepared by the cashier, who works under the supervision of the treasurer.
Instructions
Indicate whether each of the procedures of internal control over cash represents (1) a strength or (2) a weakness. For each weakness, indicate why it exists.
The cash account for Bonita Medical Co. at September 30, 2008, indicated a balance of $5,335.30. The bank statement indicated a balance of $5,604.60 on September 30, 2008. Comparing the bank statement and the accompanying canceled checks and memoranda with the records revealed the following reconciling items:
a. Checks outstanding totaled $4,790.45.
b. A deposit of $9,226.15, representing receipts of September 30, had been made too late to appear on the bank statement.
c. The bank had collected $7,725 on a note left for collection. The face of the note was $7,500.
d. A check for $4,315 returned with the statement had been incorrectly recorded by Bonita Medical Co. as $3,415. The check was for the payment of an obligation to Rowe Co. for the purchase of office equipment on account.
e. A check drawn for $230 had been erroneously charged by the bank as $2,300.
f. Bank service charges for September amounted to $50.
Instructions
1. Prepare a bank reconciliation.
2. Journalize the necessary entries. The accounts have not been closed.
MD&A and Statistical Tables. The MD&A for the 2007 City and County of Denver CAFR is included as Appendix B in this chapter. On the following pages are selected tables from the statistical section of the 2007 CAFR. Use the MD&A and the provided statistical tables to complete this case.
Required
a. What are the two primary governmental activity revenue sources? What percentage of the governmental activities revenue is from each of these sources?
b. Property taxes tend to be a large part of local government tax revenue. Using information from the MD&A and the trend information provided by the statistical tables, discuss whether you believe property tax revenue will be a stable revenue source for Denver in the next two to three years. Your discussion should include any strengths and weaknesses you have found.
c. Denver also appears to rely heavily on sales taxes. Using the information from the MD&A and the trend information from the statistical tables provided, discuss whether you believe sales taxes will be a stable revenue source for Denver in the next two to three years. Your discussion should include any strengths and weaknesses you have found.
Internet Case—Popular Reports. You have just been hired as an accountant for a large metropolitan city in the eastern part of the country. Your first assignment is to assist the finance director in the preparation of a “popular report.”
The city has long been concerned with the difficulty that most citizens have in understanding its comprehensive annual financial report. The finance director tells you that she saw Hillsborough County, Florida’s popular report at a conference and was quite impressed.
Required
a. Obtain a copy of Hillsborough County’s popular report by going to also, try to obtain popular reports of other local governments by using an Internet search engine.
b. Evaluate the usefulness of the popular reports you are able to obtain from the perspective of a citizen. In particular, focus on financial accounting information. Do you have adequate information to determine whether the government has a strong financial position and condition? Does the government report any nonfinancial performance information? Explain.
Examine the CAFR. Utilizing the CAFR obtained for Exercise 1–1 and your answers to the questions asked in Exercise 1–1 and the corresponding exercises in Chapters 2 through 8, comment on the following:
a. Analysis of Introductory Section. Does the report contain all of the introductory material recommended by the GASB? Is the introductory material presented in such a manner that it communicates significant information effectively—do you understand what the government is telling you? On the basis of your study of the entire report, list any additional information you believe should have been included in the introductory section and explain why you believe it should have been included. On the basis of your study of the entire report, do you think the introductory material presents the information fairly? Comment on any information in the introductory section you feel is superfluous, and explain why.
b. Analysis of Financial Statements.
1. Do the statements, notes, and schedules in the financial section present the information required by the GASB? Are Total columns provided in the basic financial statements and schedules for the primary government and the reporting entity? If so, are the Total columns for the current year compared with Total columns for the prior year? Are the basic financial statements and notes cross referenced to each other? Are they cross referenced to the statements and schedules of individual funds?
2. Review your answers to the questions asked in Exercises 3–1 and 4–1 in light of your study of subsequent chapters of the text and your analysis of all portions of the annual report. If you believe your earlier answers were not entirely correct, change them in accord with your present understanding of generally accepted accounting principles and proper disclosure of the financial position and financial operations of a governmental reporting entity.
3. Review your answers to Exercise 5–1 and all subsequent exercises in this series in light of knowledge you have gained since you prepared the answers. If any of your earlier answers should be changed, change them.
c. Analysis of Statistical Section. Does the statistical section present information in the five categories defined by the GASB? What tables and schedules are presented for each category? Does the information provided in each category appear to meet the purpose of the category? Explain your response.
d. GFOA Certificate of Achievement. Does the report include a copy of a GFOA Certificate of Achievement for Excellence in Financial Reporting or refer to the fact that the government has received one? If the report has been awarded a certificate, does your review indicate it was merited? If the report has not been awarded a certificate, does your review indicate that the report should be eligible for one?
e. Service Potential of the CAFR. Specify the most important information needs that a governmental annual report should fulfill for each of the following:
1. Administrators.
2. Members of the legislative branch.
3. Interested residents.
4. Creditors or potential creditors.
In what ways does the CAFR you have analyzed meet the information needs you have specified for each of the four groups, assuming that members of each group make an effort to understand reports equivalent to the effort you have made? In what way does the report fail to meet the information needs of each of the four groups?
The comprehensive annual financial report (CAFR) of a governmental reporting entity should contain a statement of revenues, expenditures, and changes in fund balances for:
Which of the following criteria regarding the relationship between a legally separate, tax exempt organization and a primary government would lead to the separate organization being reported as a component unit?
a. The primary government appoints the voting majority of the separate organization’s board of directors.
b. The primary government is entitled to or has the ability to otherwise access a majority of the economic resources received or held by the separate organization.
c. The economic resources received or held by an individual organization that the specific primary government is entitled to or has the ability to otherwise access are significant to that primary government.
Comprehensive Set of Transactions. The City of Lynnwood was recently incorporated and had the following transactions for the fiscal year ended December 31, 2011.
1. The city council adopted a General Fund budget for the fiscal year. Revenues were estimated at $2,000,000 and appropriations were $1,990,000.
2. Property taxes in the amount of $1,940,000 were levied. It is estimated that $9,000 of the taxes levied will be uncollectible.
3. A General Fund transfer of $25,000 in cash and $300,000 in equipment (with accumulated depreciation of $65,000) was made to establish a central duplicating internal service fund.
4. A citizen of Lynnwood donated marketable securities with a fair value of $800,000. The donated resources are to be maintained in perpetuity with the city using the revenue generated by the donation to finance an after school program for children, which is sponsored by the parks and recreation function. Revenue earned and received as of December 31, 2011, was $40,000.
5. The city’s utility fund billed the city’s General Fund $125,000 for water and sewage services. As of December 31, the General Fund had paid $124,000 of the amount billed.
6. The central duplicating fund purchased $4,500 in supplies.
7. Cash collections recorded by the general government function during the year were as follows:
Property taxes
$1,925,000
Licenses and permits
35,000
User charges
28,000
8. During the year the internal service fund billed the city’s general government function $15,700 for duplicating services and it billed the city’s utility fund $8,100 for services.
9. The city council decided to build a city hall at an estimated cost of $5,000,000. To finance the construction, 6 percent bonds were sold at the face value of $5,000,000. A contract for $4,500,000 has been signed for the project; however no expenditures have been incurred as of December 31, 2011.
10. The general government function issued a purchase order for $32,000 for computer equipment. When the equipment was received, a voucher for $31,900 was approved for payment and payment was made.
Required
Prepare all journal entries to properly record each transaction for the fiscal year ended December 31, 2011. Use the following funds and government wide activities, as necessary:
General Fund
GF
Capital projects fund Internal service fund
CPF ISF
Permanent fund
PF
After School Fund (a special revenue fund)
SRF
Enterprise fund
EF
Governmental activities
GA
Each journal entry should be numbered to correspond with each transaction. Do not prepare closing entries. Your answer sheet should be organized as follows:
General Fund Adjustments. The City of Allenton has engaged you to examine its June 20, 2011, financial statements. You are the first CPA ever engaged by the city and you find that the city’s accounting staff is unfamiliar with GAAP accounting and reporting requirements. Following is the pre closing trial balance of the General Fund as of June 30, 2011.
Debits
Credits
Cash
$ 460,000
Taxes Receivable—Current
169,200
Estimated Uncollectible Taxes—Current
$ 18,000
Taxes Receivable—Delinquent
38,000
Estimated Uncollectible Taxes—Delinquent
30,200
Equipment
66,000
Donated Land
120,000
Estimated Revenues
1,320,000
Appropriations
1,378,000
Expenditures—Principal
90,000
Expenditures—Other
1,152,000
Bonds Payable
200,000
Revenues
1,384,000
Accounts Payable
76,000
Budgetary Fund Balance
58,000
Fund Balance
$3,473,200
387,000 $3,473,200
Additional information is as follows:
1. The estimated uncollectible amount of $18,000 for current year taxes receivable was determined to be adequate. The tax year coincides with the fiscal year.
2. The city purchased $66,000 of equipment during the year.
3. The Expenditures—Principal account reflects the annual retirement of general obligation bonds issued in 2010. Interest payments of $12,000 for this bond issue are included in the Expenditures—Other account.
4. The General Fund’s outstanding purchase orders as of June 30, 2011, totaled $11,300. These purchase orders were not recorded in the books.
5. The balance in the Revenues account included a credit of $100,000 for a note issued to a bank to obtain cash in anticipation of property tax collections, and a credit of $120,000 for donated land to be used by public works. As of June 30, 2011, the note was still outstanding.
Required
The foregoing information disclosed by your examination was recorded only in the General Fund even though a debt service fund is used to account for debt, using resources provided by the General Fund. Prepare the adjusting journal entries necessary to correct the General Fund and to record information for the debt service fund, assuming the financial statements are to be prepared in conformity with GAAP.
9–6 Matching. Section A provides a list of transactions or events that occurred during the year, followed by Section B, a list of the possible effects each transaction or event has on adjusting net asset accounts at year end, assuming that all temporary accounts have already been closed to the account Net Assets—Unrestricted.
Section A
1. Depreciation was recorded for the year.
2. A fully depreciated computer was sold for $50.
3. Bonds issued to construct the new library were retired.
4. Construction expenditures were incurred for the new fire substation.
5. Cash was set aside for future debt retirement.
Section B
a. Restricted Net Assets is increased and Unrestricted Net Assets is decreased.
b. Restricted Net Assets is decreased and Unrestricted Net Assets is increased.
c. Invested in Capital Assets, Net of Related Debt is increased and Unrestricted Net Assets is decreased.
d. Invested in Capital Assets, Net of Related Debt is decreased and Unrestricted Net Assets is increased.
e. None of the above.
Required
Identify how the net asset categories would need to be adjusted for each of the transactions. For the statement in Section A, select the appropriate answer from
Government wide Financial Statements. Following is the governmental activities pre closing trial balance for the Town of Freaz. Freaz is a relatively small town and, as a result, it has only governmental funds (i. e., it uses no proprietary funds). There are no component units. To complete the financial statements for its annual report, the town must prepare a government wide statement of net assets and a statement of activities.
TOWN OF FREAZ Pre Closing Trial Balance As of June 30, 2011 (000s omitted)
Debits
Credits
Cash
$ 3,639
Investments
7,299
Taxes Receivable—Delinquent
5,788
Estimated Uncollectible Delinquent Taxes
$ 49
Due from Other Funds
645
Due from Other Governments
6,343
Land
8,720
Buildings
25,680
Accumulated Depreciation—Buildings
8,021
Infrastructure
85,768
Accumulated Depreciation—Infrastructure
45,603
Machinery & Equipment
28,720
Accumulated Depreciation—Machinery & Equipment
13,785
Accounts Payable
7,764
Accrued Liabilities
4,765
Due to Other Funds
748
Current Portion of Long term Debt
8,600
Bonds Payable
28,700
Net Assets—Invested In Capital Assets,
Net of Related Debt
44,179
Net Assets—Restricted for Debt Service
2,123
Net Assets—Unrestricted
7,678
Program Revenues—General Government—
4,411
Charges for Services
Program Revenues—Public Safety—
Charges for Services
996
Program Revenues—Parks & Recreation—
Charges for Services
359
Program Revenues—General Government—
Operating Grants & Contributions
307
Program Revenues—Public Works—
Capital Grants & Contributions
1,680
General Revenues—Property Taxes
13,665
General Revenues—Interest & Penalties
746
General Revenues—Interest Income
345
Expenses—General Government
2,468
Expenses—Public Safety
11,577
Expenses—Public Works
5,311
Expenses—Parks & Recreation
1,817
Expenses—Interest on Long term Debt
749
$ 194,524
$ 194,524
Required
Using the trial balance provided by the town, prepare a government wide statement of activities and a statement of net assets. Restricted net assets for debt service increased $87 (000s omitted) for the period.
Converting from Modified Accrual to Accrual Accounting. The Village of Rodale keeps its governmental fund accounting records on a modified accrual basis. At the end of the fiscal year, the village accountant must convert the modified accrual information to accrual information to allow for preparation of the government wide financial statements. Following are several transactions identified by the accountant that will require conversion.
1. At the end of the year, depreciation expense of $674,300 was recorded on buildings and equipment.
2. Year end salaries amounting to $39,123 were accrued.
3. During the year the village acquired a vehicle at a cost of $21,369 and depreciable office equipment at a cost of $7,680. (Note: the village uses a Buildings and Equipment account.)
4. The village made the final $50,000 payment on a long term loan. Interest related to the loan was $2,250, half of which had been accrued at the end of the prior fiscal year.
5. The records indicate that the Due from Other Funds balance is $720. Of this amount, $480 is due from the Water Utility Fund for service provided by the general government; the remainder is due from a special revenue fund for services provided by the Police Department. The amount Due to Other Funds balance is $950, which the General Fund owes to the Water Utility Fund for water received.
Required
Prepare modified accrual to accrual adjustments for all of the transactions identified in Items 1–5. Your answer sheet should be organized as follows. In the first column, identify the account titles that will be affected by the adjustment. Use the second column to identify whether the account title provided is a modified accrual account or an accrual account. The adjustment columns should record the amount of the debit or credit that would need to be made to adjust information from modified accrual to accrual. Keep in mind that some transactions may not be recorded under modified accrual; in such cases, the debit and credit adjustments affect only accrual accounts since the adjustments are reflected at the government wide level only.
NASRA and the GASAC. You are an accountant with the national office of the National Association of State Retirement Administrators (NASRA) and have just been appointed by the membership as its representative to the Governmental Accounting Standards Advisory Council (GASAC) for a four year term. In preparation for the first of the three meetings this year, the outgoing representative for NASRA has suggested that you familiarize yourself with the following:
a. The mission of the NASRA and its reason for joining the GASAC in 1992.
b. The other 28 member associations of the GASAC and whether they represent users, preparers, attestors, or other groups interested in government financial reporting.
c. The status of the City of San Diego’s pension fund crisis or scandal.
Required
Use the Internet to gather information about the three areas listed above. Prepare a written summary of the information you obtain so you can review it with the outgoing representative. Include in your summary and evaluation of whether or not these are important issues for any of the other GASAC members.
Internet Case—Municipal Credit Analysts. For the fiscal year 2007, the City and County of Denver, Colorado, had approximately $4.9 billion in bonded debt. You are a senior accountant in the controller’s office of the City and County of Denver and have been asked to make a presentation at the next council meeting about how the bond rating agencies use information from the comprehensive annual financial report (CAFR) to determine the city’s bond ratings.
Required
a. What is the bond rating assigned to the City and County of Denver by each of the three major bond rating agencies—Standard and Poor’s, Fitch, and Moody’s?
b. Determine if the ratings assigned to the City and County of Denver by the rating agencies are high, average, or low by referring to the Web sites of each of the rating agencies.
c. What information from the CAFR would the rating agencies have used in assigning a bond rating to the City and County of Denver? What other information might the rating agencies find useful?
Financial Trends. You are a new city council person for the City of Scottsdale, Arizona. You are aware that several cities have been in the news recently for financial crises for which the council or board is being held accountable. The governing bodies have been criticized for not being aware of the negative signals and trends that obviously contributed to challenging financial situations. Although you were assured at the first few council meetings that the city was overall in good financial shape, you want to be sure you “do your homework” and assess the financial condition of the city for yourself.
You know that the City of Scottsdale, Arizona, prepares a Financial Trends report each year based on the ICMA’s Financial Trends Monitoring System and that it posts.
Required
a. Go to the city’s Web site and view a copy of the Financial Trends report.
b. Prepare a list of questions for the next city council meeting. Your questions should help you focus on whether you and the other council members should be concerned about any negative trends.
Analysis of Overall Performance. The City of Edmond, Oklahoma, uses the Crawford Performeter® as a financial analysis tool and presents the results of this analysis in its Managements’s Discussion and Analysis in the annual audited financial statements. For the year ended June 30, 2006, values for the following indicators were presented for the city as a whole:
Per for meter Rating
Benchmark
Computation
for 2006
Rating:
10
5
Unrestricted net assets as a
percentage of annual revenue
50%
30%
32%
Percentage of assets funded
with outstanding debt
<10%
50%
40%
Change in net assets
10%
0%
14%
Inter period equity—percentage
of current year expenses funded
by current year revenues
100%
95%
129%
Required
a. Use Illustration 10–7 in the text and assign a rating to each of the ratios provided (from 1 = lowest or worst to 10 = highest or best), calculate a score using the suggested weights provided, and compute an overall rating of the financial health and performance of this city for FY 2006.
b. Describe in your own words whether this city is in good or bad shape based on these indicators. Do the ratios point to areas to which the city should pay particular attention in the future?
c. What other information would you find useful in analyzing the financial performance of this city for this year?
Examine the CAFR. Utilizing the CAFR obtained for Exercise 1–1 and your answers to the questions asked in Chapters 1 through 9, assess the financial condition of the government. For purposes of this project, financial condition is broadly defined as a city’s ability to provide an adequate range of services on a continuing basis. Specifically, it refers to a city’s ability to (1) maintain existing service levels, (2) withstand major economic disruptions, and (3) meet the demands of a changing society in a dynamic economy. Examine the following issues and questions.
a. Analysis of revenues and revenue sources.
(1) How stable and flexible are the city’s revenue sources in the event of adverse economic conditions?
(2) Is the revenue base well diversified, or does the city rely heavily on one or two major sources?
(3) Has the city been relying on intergovernmental revenues for an excessive portion of its operating expenditures?
(4) What percentage of total expenses of governmental activities is covered by program revenues? By general revenues?
(5) Do any extraordinary or special items reported in the statement of activities deserve attention?
b. Analysis of reserves.
(1) Are the levels of financial reserves (i.e., fund balances, contingency funds, and unrestricted net assets) adequate to meet unforeseen operational requirements or catastrophic events?
(2) Is insurance protection adequate to cover losses due to lawsuits or damage to property?
(3) Is an adequate amount of cash and securities on hand, or could the city borrow quickly to cover short term obligations?
c. Analysis of expenditures and expenses.
(1) Do any components of expenditures and, at the government wide level, expenses exhibit sharp growth?
(2) Is adequate budgetary control being exercised over expenditures?
(3) How does the growth pattern of operating expenditures and expenses over the past 10 years compare with that of revenues?
d. Analysis of debt burden.
(1) What has been the 10 year trend in general obligation long term debt relative to trends in population and revenue capacity?
(2) Are significant debts of other governments (e.g., a school district, a county) supported by the same taxable properties? What has been the trend for this “overlapping” debt?
(3) Are there significant levels of short term operating debt? If so, has the amount of this debt grown over time?
(4) Are there any significant debts (e.g., lease obligations, unfunded pension liabilities, accrued employee benefits) or contingent liabilities?
(5) Are any risky investments such as derivatives disclosed in the notes to the financial statements? Are the types of investments adequately explained, and are their risks adequately disclosed?
e. Socioeconomic factors.
What have been the trends in demographic and economic indicators, such as real estate values, building permits, retail sales, population, income per capita, percent of population below the poverty level, average age, average educational level, employment and unemployment, and business licenses?
f. Potential “red flags” or warning signs.
(1) Decline in revenues.
(2) Decline in property tax collection rate.
(a) Less than 92 percent of current levy collected?
(b) Property taxes more than 90 percent of the legal tax limit?
(c) Decreasing tax collections in two of the last three years?
(3) Expenditures increasing more rapidly than revenues.
(4) Declining balances of liquid resources and fund balances.
(a) General Fund deficit in two or more of the last five years?
(b) General Fund balance less than 5 percent of General Fund revenues and other financial sources?
(5) Reliance on nonrecurring (i.e., special item) revenues to support current period operations.
(6) Growing debt burden.
(a) Short term debt more than 5 percent of operating revenues?
(b) Two year trend of increasing short term debt?
(c) Short term interest and current year debt service on general obligation debt more than 20 percent of operating revenues?
(d) Debt per capita ratio 50 percent higher than four years ago?
(7) Growth of unfunded pension and other employee related benefits such as compensated absences and postemployment health care benefits.
(8) Deferral of needed maintenance on capital plant.
(9) Decrease in the value of taxable properties, retail sales levels, or disposable personal income.
(10) Decreasing revenue support from federal or state government.
(11) Increasing unemployment.
(12) Unusual climatic conditions or the occurrence of natural disasters.
(13) Ineffective management and/or dysfunctional political circumstances.
Required
a. Calculate, insofar as possible, the financial ratios in Illustrations 10–3 and 10–4 of the text. Evaluate the ratios in terms of the red flags and benchmarks provided in Illustrations 10–6 and 10–7 and long term trend data for each ratio, if available. List any assumptions you made.
b. Locate any additional data that you think may be useful in assessing the financial condition of this city; for example, see the U.S. Census Bureau’s Web site at www.census.gov and the Web sites of cities you consider comparable in size or other attributes to this city.
c. Prepare a report on the results of your analysis. The report should have an appendix providing a few graphs and/or tables to support your analysis. In particular, graphs showing revenues, expenditures, and key debt ratios for the past 10 years and selected demographic and socioeconomic trends are helpful. You may want to include some of the ratios calculated in part b in an appendix. Be succinct and include only data relevant to your analysis. Organize your report along the lines of the ratios evaluated in part a.
Financial Condition. Write the letters a through o on a sheet of paper. Beside each letter, put a plus (+) if a high or increasing value of the item is generally associated with stronger financial condition, a minus ( ) if a high or increasing value of the item is generally associated with a weaker financial condition, and NE if the item generally has no effect on the financial condition or the direction of the effect cannot be predicted.
a. Unfunded pension liability.
b. Level of overlapping debt.
c. Reserves for self insurance.
d. Potential for natural disasters.
e. Level of business activity.
f. Median age of citizens.
g. Unemployment rate.
h. Restrictions on revenues.
i. Personal income per capita.
j. Inflation rate.
k. Percentage of households below the poverty level.
Benchmarks. Examine the following tables from the 2009 Financial Trend Monitoring Report for the Town of Oakdale that reports on fiscal year 2008. The performance indicators selected are total revenue and revenue per capita. The town provides three reference groups with which to compare Oakdale: Aaa rated municipalities, comparison municipalities, and the state median. Since local government budgeting in this state is driven by the property tax levy cap, this is a key variable in comparing municipalities.
Aaa Rated
Municipality
FY08 Total
Revenue
FY08 Rev
per Cap
State
Rank
Comparison
Municipality
FY08 Total
Revenue
FY08 Rev
per Cap
State
Rank
Delta
$ 49,794,904
$4,342
12
Dover
$356,895,723
$3,521
27
Monroe
111,784,312
3,683
21
Oakdale
175,058,152
3,065
45
Schoolcraft
47,219,656
3,605
24
Cook
71,477,390
2,954
51
Dover
356,895,723
3,521
27
Lakeview
245,812,303
2,932
53
Bentley
103,338,507
3,307
33
Frankenmuth
76,196,553
2,863
63
Oakdale
175,058,152
3,065
45
Walden
59,310,311
2,850
65
Harris
59,373,338
2,986
48
Superior
161,444,163
2,726
80
Cook
71,477,390
2,954
51
Cedar
89,441,958
2,644
97
Lakeview
245,812,303
2,932
53
Pittsfield
169,322,957
2,531
116
Caro
49,726,361
2,926
55
Lodi
99,100,870
2,338
168
Frankenmuth
76,196,553
2,863
63
Huron
120,977,460
2,169
210
Walden
59,310,311
2,850
65
Pineview
116,134,368
2,151
217
Aaa Rated
FY08 Total
Revenue
FY Rev
per Cap
Oakdale
Median $ 73,836,972
$3,026
Aaa Rated LQ
1.01
Comparison
RG Median 118,555,914
2,788
Comparison RG LQ
1.1
State Median 23,487,291
2,314
State LQ
1.32
where RG = reference group
LQ = location quotient showing how much above or below the median this government is.
Required
a. Prepare a histogram or bar graph that shows Oakdale in relation to the three reference groups, Aaa rated median, comparison reference group, and state median for FY 2008 total revenue and a separate graph for FY 2008 revenue per capita.
b. Evaluate the financial performance of Oakdale for FY 2008. Use information from the tables and the graph you prepared for Part a to support your analysis.
c. What other performance measures would you like to see before you conclude the town is in good or bad shape for the fiscal year shown?
10–5 Financial Trend Monitoring System—Reserves. The City of Scottsdale, Arizona, provides the following report on the following page about its reserve policies on page 12 of its October 2007 financial trends booklet.
Required
a. Refer to Illustration 10–1. To which categories of factors affecting financial condition do you believe this statement belongs?
b. Assess the adequacy of this note. Do you need more information to understand how the reserve financial policy affects the city’s financial condition? Explain.
Comparative Ratios. The government wide financial statements for the City of Arborland for a three year period are presented on the following pages. Additional information follows: Population: Year 2011: 30,420, Year 2010: 28,291, Year 2009: 26,374. Debt limit remained at $20,000,000 for each of the three years. Net cash from operations is generally 80 percent of total revenues each year.
Required
a. Which of the financial performance measures in Illustration 10–4 can be calculated for the City of Arborland based on the information that is provided?
b. Calculate those ratios identified in part a for FY 2011. Show your computations.
c. Provide an overall assessment of the City of Arborland’s financial condition using all the information provided, both financial and nonfinancial. Use information from the prior years to form your assessment.
Argonaut Co. records all cash receipts on the basis of its cash register tapes. Argonaut Co. discovered during November 2008 that one of its sales clerks had stolen an undetermined amount of cash receipts when she took the daily deposits to the bank. The following data have been gathered for November:
Cash in bank according to the general ledger
$12,510.45
Cash according to the November 30, 2008 bank statement
22,060.65
Outstanding checks as of November 30, 2008
6,381.42
Bank service charge for November
35.00
Note receivable, including interest collected by bank in November
7,140.00
No deposits were in transit on November 30, which fell on a Sunday.
a. Determine the amount of cash receipts stolen by the sales clerk.
b. What accounting controls would have prevented or detected this theft?
Central Duplicating Internal Service Fund. As of September 30, 2010, the Central Duplicating Fund of the Town of Fredericksburg had the following post closing trial balance:
Debits
Credits
Cash
$ 15,000
Due from Other Funds
20,200
Service Supplies Inventory
35,300
Machinery and Equipment
300,000
Allowance for Depreciation
$ 90,000
Due to Federal Government
1,500
Due to Other Funds
800
Accounts Payable
12,700
Net Assets—Invested in Capital Assets
210,000
Net Assets—Unrestricted
$370,500
55,500 $370,500
During the fiscal year ended September 30, 2011, the following transactions (summarized) occurred:
1. Employees were paid $290,000 wages in cash; additional wages of $43,500 were withheld for federal income and social security taxes. The employer’s share of social security taxes amounted to $23,375.
2. Cash remitted to the federal government during the year for withholding taxes and social security taxes amounted to $65,500.
3. Utility bills received from the Town of Fredericksburg’s Utility Fund during the year amounted to $23,500.
4. Office expenses paid in cash during the year amounted to $10,500.
5. Service supplies purchased on account during the year totaled $157,500.
6. Parts and supplies used during the year totaled $152,300 (at cost).
7. Charges to departments during the fiscal year were as follows:
General Fund
$308,700
Street Fund
279,300
8. Unpaid balances at year end were as follows:
General Fund
$10,000
Street Fund
20,000
9. Payments to the Utility Fund totaled $21,800.
10. Accounts Payable at year end amounted to $13,250.
11. Annual depreciation rate for machinery and equipment is 10 percent.
12. Revenue and expense accounts for the year were closed.
Required
a. Prepare a statement of revenues, expenses, and changes in net assets for the year.
b. Comment on the evident success of the pricing policy of this fund, assuming that user charges are intended to cover all operating expenses, including depreciation, but are not expected to provide a net income in excess of 3 percent of billings to departments.
c. Prepare a statement of net assets for the Central Duplicating Fund as of September 30, 2011.
d. Prepare a statement of cash flows for the Central Duplicating Fund for the year ended September 30, 2011.
Central Garage Internal Service Fund. The City of Ashville operates an internal service fund to provide garage space and repairs for all city owned and operated vehicles. The Central Garage Fund was established by a contribution of $300,000 from the General Fund on July 1, 2008, at which time the land and building were acquired. The post closing trial balance at June 30, 2010, was as follows:
Debits
Credits
Cash
$110,000
Due from Other Funds
9,000
Inventory of Supplies
90,000
Land
50,000
Building
250,000
Allowance for Depreciation—Building
$ 20,000
Machinery and Equipment
65,000
Allowance for Depreciation—
Machinery and Equipment
12,000
Vouchers Payable
31,000
Net Assets—Invested in Capital Assets
333,000
Nets Assets—Unrestricted
$574,000
178,000 $574,000
The following information applies to the fiscal year ended June 30, 2011:
1. Supplies were purchased on account for $92,000; the perpetual inventory method is used.
2. The cost of supplies used during the year ended June 30, 2011, was $110,000. A physical count taken as of that date showed materials and supplies on hand totaled $72,000 at cost.
3. Salaries and wages paid to employees totaled $235,000, including related costs.
4. Billings totaling $30,000 were received from the enterprise fund for utility charges. The Central Garage Fund paid $27,000 of the amount owed.
5. Depreciation of the building was recorded in the amount of $10,000; depreciation of the machinery and equipment amounted to $9,000.
6. Billings to other departments for services provided to them were as follows:
General Fund
$270,000
Special Revenue Fund
37,000
Water and Sewer Utility Fund
90,000
7. Unpaid inter fund receivable balances were as follows:
6/30/10
6/30/11
General Fund
$2,500
$3,000
Special Revenue Fund
3,500
7,000
Water and Sewer Utility Fund
3,000
2,000
8. Vouchers payable at June 30, 2011, were $16,000.
9. For June 30, 2011, closing entries were prepared for the Central Garage Fund
Required
a. Assume all expenses at the government wide level are charged to the General Government function. Prepare journal entries to record all of the transactions for this period in the Central Garage Fund accounts and in the governmental activities accounts.
b. Prepare a statement of revenues, expenses, and changes in net assets for the Central Garage Fund for the period ended June 30, 2011.
c. Prepare a statement of net assets for the Central Garage Fund as of June 30, 2011.
d. Explain what the Central Garage Fund would need to report at the governmental activities level, and where the information would be reported.
Net Asset Classifications. During the past year, Oak City had a number of transactions that impacted net asset classifications of its produce market, which is operated as an enterprise fund. All nominal accounts for the period have been closed to unrestricted net assets. For reporting purposes, the city’s finance director is trying to update the net asset categories to properly reflect current balances in each of the three net asset categories based on the following transaction information.
1. For the year, depreciation expense totaled $534,000.
2. During the year a piece of equipment with a carrying value of $2,610 was sold for its carrying value.
3. During the year $1,000,000 in deferred serial bonds was issued to construct a building to house the produce market. At the end of the year, construction work in progress for the building totaled $948,000. It is expected the building will be completed at the beginning of the next year.
4. To retire the $1,000,000 deferred serial bonds, $25,000 cash was placed in a sinking fund.
5. A $5,000 principal payment was made on a capital lease.
Required
To assist the finance director you have been asked to provide a journal entry for each of the above five items. Your journal entries should indicate the effect of each item on the net asset categories—invested in capital assets, net of related debt; restricted; and unrestricted.
Parking Facilities Fund. The City of Dalton accounts for its parking facilities as an enterprise fund. For the year ended December 31, 2011, the pre closing trial balance for the Parking Facilities Fund is provided.
Debits
Credits
Cash & Cash Equivalents
$ 869,168
Accounts Receivable
3,607
Allowance for Uncollectible Accounts
$ 72
Restricted Cash & Cash Equivalents
993,322
Land
3,021,637
Buildings and Equipment
23,029,166
Accumulated Depreciation
5,623,315
Accounts & Accrued Payables
312,830
6 month Note Payable
360,000
Bonds Payable
15,579,325
Net Assets—Invested in Capital Assets,
Net of Related Debt
4,931,749
Net Assets—Restricted
951,996
Net Assets—Unrestricted
765,893
Charges for Services
1,640,261
Interest Income
251,480
Personnel Expense
852,380
Utilities Expense
100,726
Repairs & Maintenance Expense
64,617
Supplies Expense
17,119
Depreciation Expense
578,861
Interest Expense
874,909
Interfund Transfer Out
11,409
$30,416,921
$30,416,921
Additional information concerning the Parking Facilities Fund is as follows:
1. All bonds payable were used to acquire property, plant, and equipment.
2. During the year, a principal payment of $500,000 was made to retire a portion of the bonds payable.
3. Equipment with a carrying value of $4,725 was sold for its carrying value.
4. Total cash received from customers was $1,640,155 and cash received for interest and dividends was $251,480; $150,000 of this amount is restricted cash.
5. Cash payments included $750,828 to employees, $365,137 to vendors, $874,909 for interest on bonded debt, and $11,409 to subsidize public works (the General Fund).
6. The beginning balance in Accounts Receivable was $3,501, and Accounts & Accrued Payables was $393,953.
7. The net asset categories have not been updated to reflect correct balances as of the December 31, 2011, year end.
Required
a. Prepare the statement of revenues, expenses, and changes in fund net assets for the Parking Facilities Fund as of December 31, 2011.
b. Prepare the statement of net assets for the Parking Facilities Fund as of December 31, 2011.
c. Prepare the statement of cash flows for the Parking Facilities Fund as of December 31, 2011.
Central Station Fund. The Town of Elizabeth operates the old train station as an enterprise fund. The train station is on the national register of historic buildings.
Since the town has held the building for such a long time, the Central Station Fund has no long term debt. The only capital assets recorded by the Central Station Fund are machinery and equipment. Businesses rent space in the building and the town provides all services related to the operation and maintenance of the building. Following is information related to the fund’s 2011 operating activities.
1. Rental income of $94,444 was accrued. Subsequently, cash in the amount of $90,210 was received on accounts.
2. Cash expenses for the period included: administrative services, $25,205; maintenance and repairs, $72,882; supplies and materials, $7,792; and utilities, $30,124.
3. The Central Station Fund received a $60,000 transfer of funds from the General Fund.
4. Adjustments were made for depreciation ($3,519) and for uncollectible accounts ($667).
5. At the end of the period, nominal accounts were closed.
Required:
a. Prepare general journal entries to record the Central Station Fund’s operating activities for the year.
b. Prepare a statement of revenues, expenses, and changes in fund net assets. The net asset balance at the beginning of the period was $60,129.
c. Based on the information provided, does it appear that the Central Station Fund is required to be recognized as an enterprise fund under GASB standards? Explain your answer.
d. Assuming you are the town’s manager, discuss your concerns about the Central Station Fund.
Enterprise Fund Journal Entries and Financial Statements. Following is the June 30, 2010, statement of net assets for the City of Bay Lake Water Utility Fund.
CITY OF BAY LAKE
Water Utility Fund
Statement of Fund Net Assets
June 30, 2010
Assets
Current assets:
Cash and investments
$ 1,775,019
Accounts receivable (net of $13,367
provision for uncollectible accounts)
306,869
Accrued utility revenue
500,000
Due from General Fund
29,311
Accrued interest receivable
82,000
Total current assets
2,693,199
Restricted assets:
Cash
9,193
Capital assets:
Land
$1,780,945
Buildings (net of $3,420,000 in accumulated
depreciation)
5,214,407
Machinery and equipment (net of
$5,129,928 in accumulated depreciation)
8,488,395
Total capital assets (net)
15,483,747
Total Assets
18,186,139
Liabilities
Current liabilities:
Accounts payable
532,047
Accrued interest payable
131,772
Current portion of long term debt
400,000
1,063,819
Total current liabilities
Liabilities payable from restricted assets:
Customer deposits
9,193
Long term liabilities:
Revenue bond payable
11,600,000
Total Liabilities
12,673,012
Net Assets
Invested in capital assets, net of related debt
3,483,747
Unrestricted
2,029,380
$ 5,513,127
Required
a. For fiscal year 2011, prepare general journal entries for the Water Utility Fund using the following information.
(1) The amount in the Accrued Utility Revenue account was reversed.
(2) Billings to customers for water usage during fiscal year 2011 totaled $2,982,557; $193,866 of the total was billed to the General Fund.
(3) Cash in the amount of $260,000 was received. The cash was for interest earned on investments and $82,000 in accrued interest.
(4) Expenses accrued for the period were: management and administration, $360,408; maintenance and distribution, $689,103; and treatment plant, $695,237.
(5) Cash receipts for customer deposits totaled $2,427.
(6) Cash collections on customer accounts totaled $2,943,401, of which $209,531 was from the General Fund.
(7) Cash payments for the period were as follows: Accounts Payable, $1,462,596; interest (which includes the accrued interest payable), $395,917; bond principal, $400,000; machinery and equipment, $583,425; and return of customer deposits, $912.
(8) A state grant amounting to $475,000 was received to help pay for new water treatment equipment.
(9) Accounts written off as uncollectible totaled $10,013.
(10) The utility fund transferred $800,000 in excess operating income to the General Fund.
(11) Adjusting entries for the period were recorded as follows: depreciation on buildings was $240,053 and on machinery and equipment it was $360,079; the allowance for uncollectible accounts was increased by $14,913; an accrual for unbilled customer receivables was made for $700,000; accrued interest income was $15,849; and accrued interest expense was $61,406.
(12) The Revenue Bond Payable account was adjusted by $400,000 to record the current portion of the bond.
(13) Closing entries and necessary adjustments were made to the net asset accounts.
b. Prepare a statement of revenues, expenses, and changes in fund net assets for the Water Utility Fund for the year ended June 30, 2011.
c. Prepare a statement of net assets for the Water Utility Fund as of June 30, 2011.
d. Prepare a statement of cash flows for the Water Utility Fund as of June 30, 2011.
7–9 Proprietary Fund Financial Statements. Von County has prepared the following statement of revenues, expenses, and changes in fund net assets for its proprietary funds. The county has three enterprise funds and two internal service funds.
VON COUNTY
Statement of Revenues, Expenses, and Changes in Fund Net Assets
Proprietary Funds
for the Year Ended December 31, 2011
(amounts expressed in thousands)
Total
Enterprise
Funds
Total
Internal
Service
Funds
Total
Revenues
Charges for services
$ 61,309
$10,621
$ 71,930
Investment income
1,086
59
1,145
Total Revenues
62,395
10,680
73,075
Expenses
Personnel services
24,196
5,681
29,877
Supplies and materials
11,540
3,293
14,833
Interest expense
6,904
172
7,076
Depreciation
11,213
2,076
13,289
Loss on disposal of capital assets
14
14
Interfund Transfer out
186
0
186
Total Expenses
54,053
11,222
65,275
Change in net assets
8,342
(542)
7,800
Special item—Loss on Sale
(3,794)
(3,794)
Net assets—January 1, 2011
288,611
3,337
291,948
Net assets—December 31, 2011
$293,159
$ 2,795
$295,954
Required
The statement as presented is not in accordance with GASB standards. Identify the errors and explain how the errors should be corrected in order to conform with GASB standards. Along with the information in Chapter 7, Illustration A1 8 will be helpful in identifying and correcting the errors.
Statement of Cash Flows for Proprietary Funds. From the right hand column, choose the letter that corresponds to the section of the statement of cash flows where the activity listed in the left hand column would be reported.
Identification of Fiduciary Funds. Following is a list of fund names and descriptions of funds from comprehensive annual financial reports (CAFRs).
Required
For each fund, indicate which type of fund should be used to account for the activities and explain why that fund is most appropriate.
a. Tri Centennial Fund. Accounts for money raised or contributed by several local area governments and other organizations. The purpose is to ensure availability of resources to celebrate the United States Tri Centennial in 2076.
b. Perpetual Care Fund. Accounts for endowed gifts and investment earnings dedicated to perpetual care of the city’s cemeteries.
c. Debt Service Trust Fund. The city collects special assessments from citizens in designated special benefit districts that are intended for debt service on bonds issued for projects within the district. The city bears no responsibility for this debt.
d. School Impact Fee Fund. The city collects school impact fees as part of the cost of building permits issued. Money must be remitted periodically to the local school district, a legally separate government that is not a component unit of the city.
e. Housing Rehabilitation Fund. Accounts for several revolving funds that provide low interest loans for housing. The collection of the loans is used to run the program and make new loans to qualified citizens. Several government sources provided the start up funds.
f. Payroll Fund. The city has established a fund in which all payroll deductions are reported.
g. Telephone Commissions Fund. The city collects commissions on pay telephones used by jail inmates. The funds are used to provide inmates such benefits as library resources and fitness equipment.
h. Block Grant Fund. The state receives federal funds for the homeless which it passes through to local not for profit organizations. The only responsibility the state has is to contribute an additional amount of funds (match) to the federal grant.
i. Health Benefits Fund. The county has agreed to pay a portion of the health insurance premiums for employees when they retire. Contributions for the benefit are paid into this fund.
j. Unclaimed Property Fund. The state has established a fund to account for abandoned and unclaimed property. The property is held in the fund for 10 years. If a legal claimant to the property is not found within the 10 year time period, the property reverts to the state.
Other Postemployment Benefit (OPEB) Plans. GASB standards require that governments report other postemployment benefits offered to employees. A typical example of such benefits is health care provided to retirees. It is estimated that the unrecorded and unfunded liability related to OPEB is huge. To investigate the extent of the problem, examine the notes of the most recent CAFRs for the City and County of Denver (www.denvergov.org/controller) and the City of New York (www.comptroller.nyc.gov).
a. Examine the Schedule of Funding Progress in the pension plan note (section IV, note G, in Denver’s 2007 CAFR) for the City and County of Denver. For the most recent year, how large is the actuarial accrued liability (AAL) for Denver’s health benefits plan (titled DERP Health Benefits in the schedule) and what has been the trend in the funded ratio? Discuss how the funded ratio for the Denver Employees Retirement Plan (DERP) compares to that of the health benefits plan.
b. Examine the Schedule of Funding Progress for the health benefits plan (New York City Health Benefits Plan) for the City of New York. The schedule can be found in the Other Information note (part 3 of note E in New York City’s 2007 CAFR). For the most recent year, how large is the AAL for the New York City Health Benefits Plan and what does the funded ratio indicate about the status of the plan?
c. Compare the funded status of Denver’s health benefits plan to that of New York City’s health benefits plan.
Examine a CAFR. Utilizing the annual report obtained for Exercise 1–1, follow these instructions:
a. Agency Funds. Are employees’ and employers’ FICA tax contributions and contributions to other retirement funds reported in the General Fund, an agency fund, or in some other manner (describe)? Does the government operate a tax agency fund or participate in a tax agency fund operated by another government? Does the government act as agent for owners of property within a special assessment district and for the creditors of those property owners? Does the government operate one or more pass through agency funds? If so, describe.
b. Investment Trust Funds. Does the government operate, or participate in, a cash and investments pool? If so, is the pool operated as an investment trust fund? If there is a cash and investment pool and it is not reported as an investment trust fund, how is it reported? Explain.
c. Private purpose Trust Funds. Does the government operate one or more private purpose trust funds? If yes, explain the purpose(s).
d. Pension Trust Funds. Are the government employees covered by a retirement fund operated by the government, by the state, by the federal Social Security Administration, or by two or more of these? If the government operates one or more pension plans, or retirement systems, are the plan statements accompanied by an actuary’s report, or is a reference made to the actuary’s report in the notes to the financial statements? Is a net pension obligation (NPO) reported in the government wide statement of net assets and/or in a proprietary fund? Is all the pension information specified by GASB standards and discussed in Chapter 8 presented in the notes to the financial statements? Are all required supplementary schedules and related notes reported in the comprehensive annual financial report?
e. Fiduciary Fund Financial Statements. Are all fiduciary funds shown in a statement of fiduciary net assets and a statement of changes in fiduciary net assets? Does the financial report state the basis of accounting used for trust and agency funds? Are agency funds properly disclosed in the financial statements? Does the report contain a schedule or list of investments of trust funds? Are investments reported at fair value? Is the net increase (decrease) shown separately from interest and dividend income? If trust funds own depreciable assets, is depreciation taken? If so, is depreciation considered a charge against principal or against income?
The city council of the City of Cadillac decided to pool the investments of its General Fund with that of Cadillac School District and Cadillac Township, each of which carried its investments at fair value as of the prior balance sheet date. All investments are revalued to current fair value at the date of the creation of the pool. At that date, the prior and current fair value of the investments of each of the participants were as follows:
Investments
Prior Fair Value
Current Fair Value
General Fund
$ 600,000
$ 590,000
Cadillac School District
3,600,000
3,640,000
Cadillac Township
1,800,000
1,770,000
Total
$6,000,000
$6,000,000
1. At the date of the creation of the investment pool, each of the participants should:
a. Debit its Fund Balance account and credit its Investments account for the prior fair value of the assets transferred to the pool.
b. Debit or credit its Investments account as needed to adjust its carrying value to current fair value. The offsetting entry in each fund should be to Fund Balance.
c. Debit Equity in Pooled Investments for the current fair value of investments pooled, credit Investments for the prior fair value of investments pooled, and credit or debit Revenues—Change in Fair Value of Investments for the difference.
d. Make a memorandum entry only.
2. At the date of creation of the pool, the City of Cadillac should account for all the pooled investments in:
a. An investment trust fund at fair value at the date the pool is created.
b. An agency fund at fair value as of the prior balance sheet date.
c. Its General Fund at fair value at the date the pool is created.
d. Its General Fund at fair value as of the prior balance sheet date.
3. One day after creation of the pool, the investments that had belonged to Cadillac Township were sold by the pool for $1,760,000.
a. The loss of $40,000 is borne by each participant in proportion to its equity in the pool.
b. The loss of $10,000 is borne by each participant in proportion to its equity in the pool.
c. The loss of $40,000 is considered to be a loss borne by Cadillac Township.
d. The loss of $10,000 is considered to be a loss borne by Cadillac Township.
4. One month after creation of the pool, earnings on pooled investments totaled $59,900. It was decided to distribute the earnings to the participants, rounding the distribution to the nearest dollar. The Cadillac School District should receive:
Tax Agency Fund. The county collector of Lincoln County is responsible for collecting all property taxes levied by funds and governments within the boundaries of the county. To reimburse the county for estimated administrative expenses of operating the tax agency fund, the agency fund deducts 1 percent from the collections for the town, the school district, and the townships. The total amount deducted is added to the collections for the county and remitted to the Lincoln County General Fund. The following events occurred in 2011:
1. Current year tax levies to be collected by the agency fund were:
County General Fund
$ 2,752,000
Town of Smithton General Fund
4,644,000
Lincoln Co. Consolidated School District
7,912,000
Various townships
1,892,000
Total
$17,200,000
2. $8,400,000 of current taxes was collected during the first half of 2011.
3. Liabilities to all funds and governments as the result of the first half year collections were recorded. (A schedule of amounts collected for each participant, showing the amount withheld for the county General Fund and net amounts due the participants, is recommended for determining amounts to be recorded for this transaction.)
4. All money in the tax agency fund was distributed.
Required
a. Make journal entries for each of the foregoing transactions that affected the tax agency fund.
b. Make journal entries for each of the foregoing transactions that affected the Lincoln County General Fund. Begin with the tax levy entry, assuming 3 percent of the gross levy will be uncollectible.
c. Make journal entries for each of the foregoing entries that affected the Town of Smithton General Fund. Begin with the tax levy entry, assuming 3 percent of the gross levy will be uncollectible.
d. Which financial statements would be prepared by the tax agency fund?
Special Assessment Debt. Fawn community, located in the City of Deerville, voted to form a local improvement district to fund the construction of a new community center. The city agreed to construct the community center and administer the bond debt; however, Fawn community was solely responsible for repaying the bond issue. To administer the bond debt, the city established the Local Improvement District Fund. Following are several events connected with the Local Improvement District Fund.
1. On June 30, 2010, the city assessed levies totaling $6,000,000. The levies are payable in 10 equal annual installments with 4 1/2 percent interest on unpaid installments.
2. All assessments for the current period were collected by June 30, 2011, as was the interest due on the unpaid installments.
3. On July 1, 2011, the first principal payment of $600,000 was made to bondholders as was interest on the debt.
Required
a. What type of fund is the Local Improvement District Fund? Explain your answer.
b. Make journal entries for each of the foregoing events that affected the Local Improvement District Fund.
c. How would this fund be reported in the City of Deerville’s financial statements?
Identification of Fund. St. George County has entered into a contract for the demolition and construction of a six lane bridge. It is expected that the project will take three years to complete. The terms of the contract indicate that the county will retain 5 percent (retained percentage) from each progress billing.
The contract also requires that the retained percentage be invested and accounted for in a separate fund. Investment of the retained percentage is for the benefit of the contractor, who will receive the retained percentage and investment earnings upon successful completion and acceptance of the bridge.
Required
a. What type of fund should St. George County use to account for the retained percentage? Explain your answer.
b. Record the following events in the retained percentage fund.
1. A retained percentage was withheld from a progress payment of $900,000.
2. The retained percentage was invested in certificates of deposit.
3. Interest of $675 was received.
4. At year end, interest of $1,350 was accrued. There was no adjustment to fair value.
Investment Trust Fund. The Albertville City Council decided to pool the investments of its General Fund with Albertville Schools and Richwood Township in an investment pool to be managed by the city. Each of the pool participants had reported its investments at fair value as of the end of the last fiscal year. At the date of the creation of the pool, the fair value of the investments of each pool participant was as follows:
Investments
Prior Fair Value
Current Fair Value
City of Albertville General Fund
$ 890,000
$ 900,000
Albertville Schools
4,200,000
4,230,000
Richwood Township
3,890,000
3,870,000
Total
$8,980,000
$9,000,000
Required
a. Show the entry that should be made by the City of Albertville, Albertville Schools, and Richwood Township to do the following: (1) open a new asset account, Equity in Pooled Investments, in the amount of the current fair value of the investments transferred to the pool; (2) close the existing investments account; and (3) debit or credit the revenues account of each participant as needed to adjust for changes in fair value.
b. Show in general journal form the entries to be made in the accounts of the investment pool trust fund to record the following transactions of the first year of its operations:
(1) Record at current fair value the investments transferred to the pool; assume that the investments of the city’s General Fund were in U.S. Treasury notes and the investments of both the schools and the township were in certificates of deposit (CDs).
(2) CDs that had been recorded at a fair value of $1,000,000 matured. The pool received $1,050,000 in cash ($1,000,000 for the face of the CDs and $50,000 interest). The entire amount was reinvested in a new issue of certificates of deposit.
(3) Interest on Treasury notes in the amount of $50,000 was collected.
(4) Interest on CDs accrued at year end amounted to $28,250.
(5) At the end of the year, it was decided to compute and record the pool’s liability or net assets held for each of the three participants for its proportionate share of earnings on the pooled investments. Assume that there were no changes in the fair value of investments since the investment pool was created. Carry your computation of each participant’s proportionate share to two decimal places. Round the amount of the distribution to each fund or participant to the nearest dollar.
c. Record in each of the participant’s funds the increase in its Equity in Pooled Investment account.
d. The City of Albertville General Fund decided to withdraw $100,000 from the investment pool to obtain the cash it needed to acquire general capital assets. The investment pool trust fund sold $50,000 of its investments in U.S. Treasury notes (no interest had accrued on these investments) to obtain the cash needed for the withdrawal. Record the sale of U.S. Treasury notes. Record the cash withdrawal in the investment pool trust fund and the City of Albertville General Fund. Recalculate each participant’s proportionate share of pooled investments after the withdrawal is made.
e. Explain how the investment trust fund would report the General Fund’s interest in the investment pool and the Albertville School’s interest in the investment pool.
Pension Plan Calculation. The Village of Dover administers a defined benefit pension plan for its police and fire personnel. Employees are not required to contribute to the plan. The village received from the actuary and other sources the following information about the Public Safety Employees’ Pension Fund as of December 31, 2011.
Item
Amount
Annual required contribution
$ 606,700
Net pension obligation, 1/1/2011
535,700
Present value of net pension obligation as of 1/1/2011
268,920
Interest rate applicable to beginning net pension obligation
7%
Required
Assuming that the Village of Dover contributes $385,000 cash to the plan on December 31, 2011, calculate the employer’s
a. Annual pension cost.
b. Net pension obligation, as of December 31, 2011.
Pension Plan Financial Statements. The State of Nodak operates a Public Employees Retirement System (PERS) for all employees of the state. The pre closing trial balance of the PERS as of June 30, 2011, follows (in thousands of dollars):
Debits
Credits
Cash
$ 16,000
Accrued Interest Receivable
33,200
Investments
2,002,000
Equipment and Fixtures
25,200
Accumulated Depreciation—Equipment and
Fixtures
$ 3,100
Accounts Payable and Accruals
33,400
Net Assets Held in Trust for Pension Benefits,
July 1, 2010
1,577,000
Member Contributions
112,100
Employer Contributions
197,800
Interest and Dividend Income
199,700
Net Change in Fair Value of Investments
58,800
Annuity Benefits
53,900
Disability Benefits
14,000
Refunds to Terminated Employees
28,800
Administrative Expenses
8,800
Total
$2,181,900
$2,181,900
Required
a. Prepare a statement of changes in plan net assets for the State of Nodak Public Employees Retirement System for the year ended June 30, 2011, in as much detail as possible.
b. Prepare a statement of plan net assets as of June 30, 2011, for the State of Nodak Public Employees Retirement System.
c. Explain how the State of Nodak (the employer) would report its participation in the state PERS at the fund level and at the government wide level.
Fiduciary Financial Statements. Ray County administers a tax agency fund, an investment trust fund, and a private purpose trust fund. The tax agency fund acts as an agent for the county, a city within the county, and the school district within the county. Participants in the investment trust fund are the Ray County General Fund, the city, and the school district. The private purpose trust is maintained for the benefit of a private organization located within the county. Ray County has prepared the following statement of fiduciary net assets.
RAY COUNTY
Statement of Fiduciary Net Assets
Fiduciary Funds
June 30, 2011
(in thousands)
Trust Funds
Agency Funds
Total
Assets
Cash and cash equivalents
$ 104,747
$ 788
$ 105,535
Receivables
12,166
87,858
100,024
Investments:
Short term investments
241,645
241,645
Bonds, notes, and stock
992,226
992,226 1,439,430
Total assets
1,350,784
88,646
Liabilities
Accounts payable
61,447
61,447
Net Assets
Held in trust for:
Organizations
193,400
193,400
County
219,187
10,638
229,825
City of Leetown
383,578
23,048
406,626
Leetown School District
493,172
54,960
548,132
Total net assets
$1,289,337
$88,646
$1,377,983
Required
The statement as presented is not in accordance with GASB standards. Using Illustration A1–10 as an example, identify the errors (problems) in the statement and explain how the errors should be corrected.
Identification of Component Units. Following are descriptions of several relationships between primary governments and other organizations.*
Required
Using just the information provided, indicate whether you believe the primary government should include the organization as a component unit. Please explain your answer.
a. ABC organization operates within Mason County. The organization is legally separate and has a separately elected board. ABC organization determines and approves its own operating budget. The capital budget is submitted by ABC to Mason County for modification and approval.
b. The Atkins Convention and Visitor’s Bureau is a not for profit organization funded by a hotel tax levied by the City of Atkins. By city statute, the hotel tax is set by the city and can be used only by the Convention and Visitor’s Bureau.
c. The Sports Authority of Dawson County is a legally separate organization with its own elected board. It annually presents its budget to the Dawson County Commission for commissioners’ input and recommendations. The Sports Authority incorporates those recommendations it deems beneficial.
d. The County Aviation Authority has issued bonds that are guaranteed by the City of Middle Falls. The Aviation Authority will use its revenues to service the debt. Middle Falls believes that the probability it will have to cover any debt service requirements related to the Aviation Authority bonds is remote.
e. Help for Kids is a not for profit organization that receives funding from Alice County. Each year Help for Kids is required to submit its audited financial statements and approved budget to Alice County. County commissioners review the financial statements and budgets to ensure that the resources provided by the county are being used in an approved manner.
* Information used in this case is adapted from information provided in the GASB
(Standard costing) During July 2010, Pull Along worked on two production runs ( Jobs #918 and #2002) of the same product, a trailer hitch component. Job #918 consisted of 1,200 units of the product, and Job #2002 contained 2,000 units. The hitch components are made from 1/2_ sheet metal. Because this component is routinely produced for one of Pull Along’s long term customers, standard costs have been developed for its production. The standard cost of material for each unit is $18; each unit contains 6 pounds of material. The standard direct labor time per unit is 12 minutes for workers earning a rate of $20 per hour. The actual costs recorded for each job were as follows:
Direct Material
Direct Labor
Job #918
(7,300 pounds) $23,525
(230 hours) $4,840
Job #2002
(11,900 pounds) 37,440
(405 hours) 7,850
a. What is the standard direct cost of each trailer hitch component?
b. What was the total standard direct cost assigned to each of the jobs?
c. Compute the variances for direct material and for direct labor for each job.
d. Why should variances be computed separately for each job rather than for the aggregate annual trailer hitch component production?
(Ethics; writing) Two types of contracts are commonly used when private firms contract to provide services to governmental agencies: cost plus and fixed price con tracts. The cost plus contract allows the contracting firm to recover the costs associated with providing the product or service plus a reasonable profit. The fixed price contract provides for a fixed payment to the contractor. When a fixed price contract is used, the contractor’s profits are based on its ability to control costs relative to the price received.
In recent years, a number of contractors have either been accused, or found guilty, of improper accounting or fraud in accounting for contracts with the government. One deceptive accounting technique that is sometimes the subject of audit investigations involves cases in which a contractor is suspected of shifting costs from fixed priced contracts to cost plus contracts. In shifting costs from the fixed priced contract, the contractor not only influences costs assigned to that contract but also receives a reimbursement plus an additional amount on the costs shifted to the cost plus contract.
a. Why would a company that conducts work under both cost plus and fixed price contracts have an incentive to shift costs from the fixed price to the cost plus contracts?
b. From an ethical perspective, do you believe such cost shifting is ever justified? Explain.
(Research; quality; writing) Timbuk2 is a San Francisco company that makes a variety of messenger, cyclist, and laptop bags. The company’s allows customers to design their own size, color, and fabric bags with specific features and accessories; then the company sews the bags to the customers’ specifications.
a. Visit the company’s Web site and custom design a bag. Compare the quoted price with a bag of similar quality and features at a local store. Explain whether you think the Timbuk2 bag is a good value.
b. Why would Timbuk2 be able to produce custom made messenger bags for almost the same cost as mass produced ones?
c. Would you expect the quality of the custom produced messenger bags to be higher or lower than the mass produced ones? Discuss the rationale for your answer.
d. Why would the custom made messenger bags show a high profit margin?
(Ethics; writing) One of the main rationales for using a job order costing system is to achieve profitability by charging a price for each job that is proportionate to the related costs. The fundamental underlying concept is that the buyer of the product should be charged a price that exceeds all costs related to the job contract; thus, the price reflects the cost. However, there are settings in which the price charged to the consumer does not reflect the costs incurred by the vendor to serve that customer. This is the situation in a recent case heard by the U.S. Supreme Court. The case involves the University of Wisconsin, which charges all students a user fee and then redistributes these fees to student organizations.
The purpose of collecting the fee is to ensure that money is available to support diversity of thought and speech in student organizations. The user fee supports even unpopular causes so that the students hear a variety of voices. In total, the fee subsidized about 125 student groups. However, a group of students filed suit, claiming that students should not be required to fund causes that are inconsistent with their personal beliefs.
a. In your opinion, how would diversity of thought be affected if a student were allowed to select the organizations that would receive the student’s user fee (e.g., as with dues)?
b. Is the University of Wisconsin treating its students ethically by charging them to support student organizations for causes that conflict with their personal beliefs?
(Defective units and rework) Prudoe Compounds produces a variety of chemicals that are used by auto manufacturers in their painting processes. With each batch of chemicals produced, some spoilage naturally occurs. Prudoe Compounds includes normal spoilage cost in its predetermined OH rate. For 2010, Prudoe Compounds estimated the following:
Overhead costs, other than spoilage
$600,000
Estimated spoilage cost
50,000
Estimated sales value of spoiled materials
20,000
Estimated direct labor hours
40,000
a. Prudoe Compounds applies overhead based on direct labor hours. Calculate the predetermined OH rate for 2010.
b. For a batch of chemicals mixed in May 2010, the firm experienced normal spoilage on Job #788. The cost of the spoiled material amounted to $1,730 and the company estimated the salvage value of those materials to be $496. Journalize the entry for the spoilage.
Defective units and rework) PlastiCo produces plastic pipe to customer specifications. Losses of less than 5 percent are considered normal because they are inherent in the production process. The company applies overhead to products using machine hours. PlastiCo used the following information in setting its predetermined OH rate for 2010:
Expected overhead other than rework
$850,000
Expected rework costs
75,000
Total expected overhead
$925,000
Expected machine hours for 2010
100,000
During 2010, the following production and cost data were accumulated:
Total good production completed
2,000,000 feet of pipe
Total defects
40,000 feet of pipe
Ending inventory
75,000 feet of pipe
Total cost of direct material for Job #B316
$687,100
Total cost of direct labor for Job #B316
$157,750
Total machine hours for Job #B316
3,080
Cost of reworking defects during 2010
$75,500
Total actual overhead cost for 2010
$862,000
a. Determine the overhead application rate for 2010.
b. Determine the cost for Job #B316 in 2010.
c. Assume that the rework is normal and those units can be sold for the regular selling price. How will PlastiCo account for the $75,500 of rework cost?
d. Assume that PlastiCo does not include rework costs in developing the overhead application rate because rework is related to specific jobs. Determine the cost of Job #B316.
e. Using the information from (d), assume that 20 percent of the rework cost was specifically related to 200 feet of pipe produced for Job #B316. The reworked pipe can be sold for $3.50 per foot. What is the total cost of Job #B316?
1. Refer again. Suppose a blue chip company requests a six year financial lease for a $3,000 desk. The company has just issued five year notes at an interest rate of 6% per year. What is the break even rate in this case? Assume administrative costs drop to $200 per year. Explain why your answers to this question differ.
2. We assumed identical lease rates for old and new desks.
a. How does the initial break even lease rate change if the expected inflation rate is 5% per year? Assume that the real cost of capital does not change. ( Hint: Look at the discussion of equivalent annual costs in Chapter 6.)
b. How does your answer to part (a) change if wear and tear force Acme to cut lease rates by 10% in real terms for every year of a desk’s age?
1. Look at. How would the initial break even operating lease rate change if rapid technological change in limo manufacturing reduces the costs of new limos by 5% per year? ( Hint: We discussed technological change and equivalent annual costs.)
2. Suppose that National Waferonics has before it a proposal for a four year financial lease.
The firm constructs a table like Table 25.2 . The bottom line of its table shows the lease cash
Flows:
Year 0
Year 1
Year 2
Year 3
Lease cash flow
+62,000
26,800
22,200
17,600
These flows reflect the cost of the machine, depreciation tax shields, and the after tax lease payments. Ignore salvage value. Assume the firm could borrow at 10% and faces a 35% marginal tax rate.
a. What is the value of the equivalent loan?
b. What is the value of the lease?
c. Suppose the machine’s NPV under normal financing is $5,000. Should National Waferonics invest? Should it sign the lease?
Magna Charter has been asked to operate a Beaver bush plane for a mining company exploring north and west of Fort Liard. Magna will have a firm one year contract with the mining company and expects that the contract will be renewed for the five year duration of the exploration program. If the mining company renews at year 1, it will commit to use the plane for four more years. Magna Charter has the following choices.
• Buy the plane for $500,000.
• Take a one year operating lease for the plane. The lease rate is $118,000, paid in advance.
• Arrange a five year, noncancelable financial lease at a rate of $75,000 per year, paid in advance.
These are net leases: all operating costs are absorbed by Magna Charter. How would you advise Agnes Magna, the charter company’s CEO? For simplicity assume five year, straight line depreciation for tax purposes. The company’s tax rate is 35%. The weighted average cost of capital for the bush plane business is 14%, but Magna can borrow at 9%. The expected inflation rate is 4%. Ms. Magna thinks the plane will be worth $300,000 after five years. But if the contract with the mining company is not renewed (there is a 20% probability of this outcome at year 1), the plane will have to be sold on short notice for $400,000. If Magna Charter takes the five year financial lease and the mining company cancels at year 1, Magna can sublet the plane, that is, rent it out to another user. Make additional assumptions as necessary.
Majorn Auto Parts Store had net income of $81,000 for the year just ended. Majorn collected the following additional information to prepare its statement of cash flows for the year:
Increase in accounts receivable
$102,000
Decrease in merchandise inventory
$18,000
Decrease in accounts payable
$35,000
Increase in retained earnings
$29,000
Cash received from sale of building
$215,000
Gain on sale of building
$47,000
Depreciation expense
$32,000
Majorn uses the indirect method to prepare its statement of cash flows. What is Majorn”s net cash provided (used) by operating activities?
The following information relates to Jelsa Corporation for last year:
Net income
$64,000
Net decrease in all current assets except cash
$7,000
Net increase in current liabilities
$16,000
Dividends paid on common stock
$10,000
Depreciation expense
$8,000
Loss on sale of machinery
$5,000
What is Jelsa”s net cash provided (used) by operating activities for last year on the statement of cash flows? (Assume that current liabilities do not contain any notes payable.)
The following information relates to Siem, Inc. for last year:
Net income
$5,000
Net increase in all current assets except cash
$43,000
Net decrease in current liabilities
$27,000
Dividends paid on common stock
$25,000
Depreciation expense
$30,000
Gain on sale of building
$11,000
What is Siem”s net cash provided (used) by operating activities for last year on the statement of cash flows? (Assume that current liabilities do not contain any notes payable.)
Long term Liability Transactions. Following are a number of unrelated transactions for K Town, some of which affect governmental activities at the government wide level. None of the transactions has been recorded yet.
1. The General Fund collected $825,000 in accrued taxes, which was transferred to the debt service fund; $600,000 of this amount was used to retire outstanding serial bonds and the remainder was used to make the interest payment on the outstanding serial bonds.
2. A $5,000,000 issue of serial bonds to finance a capital project was sold at 102 plus accrued interest in the amount of $50,000. The accrued interest and the premium were recorded in the debt service fund. Accrued interest on bonds sold must be used for interest payments; the premium is designated by state law for eventual payment of bond principal.
3. The debt service fund made a $110,000 capital lease payment, of which $15,809 was interest. Funds used to make the lease payment came from a capital grant received by the special revenue fund.
4. Tax supported serial bonds with a $2,800,000 par value were issued in cash to permit partial refunding of a $3,500,000 par value issue of term bonds. The difference was settled with $700,000 that had been accumulated in prior years in a debt service fund. Assume that the term bonds had been issued several years earlier at par.
Required
Prepare in general journal form the necessary entries in the governmental activities and appropriate fund journals for each transaction. Explanations may be omitted. For each entry you prepare, name the fund in which the entry should be made.
Statement of Legal Debt Margin. In preparation for a proposed bond sale, the city manager of the City of Appleton requested that you prepare a statement of legal debt margin for the city as of December 31, 2010. You ascertain that the following bond issues are outstanding on that date:
Convention center bonds
$3,600,000
Electric utility bonds
2,700,000
General obligation serial bonds
3,100,000
Tax increment bonds
2,500,000
Water utility bonds
1,900,000
Transit authority bonds
2,000,000
You obtain other information that includes the following items:
1. Assessed valuation of real and taxable personal property in the city totaled $240,000,000.
2. The rate of debt limitation applicable to the City of Appleton was 8 percent of total real and taxable personal property valuation.
3. Electric utility, water utility, and transit authority bonds were all serviced by enterprise revenues, but each carries a full faith and credit contingency provision. By law, such self supporting debt is not subject to debt limitation.
4. The convention center bonds and tax increment bonds are subject to debt limitation.
5. The amount of assets segregated for debt retirement at December 31, 2010, is $1,800,000.
Capital Lease. The City of Jamestown has agreed to acquire a new city maintenance building under a capital lease agreement. At the inception of the lease, a payment of $100,000 is to be made; nine annual lease payments, each in the amount of $100,000, are to be made at the end of each year after the inception of the lease. The total amount to be paid under this lease, therefore, is $1,000,000. The town could borrow this amount for nine years at the annual rate of 8 percent; therefore, the present value of the lease at inception, including the initial payment, is $724,689. Assume that the fair value of the building at the inception of the lease is $750,000.
a. Show the entry that should be made in a capital projects fund at the inception of the lease after the initial payment has been made.
b. Show the entry that should be made at the inception of the lease in the government activities journal.
c. Show the entry that should be made in the debt service fund and governmental activities journal to record the second lease payment.
Comprehensive Capital Assets/Serial Bond Problem. Transaction data related to the City of Chambers’s issuance of serial bonds to finance street and park improvements follow. Utilizing worksheets formatted as shown at the end of the problem, prepare all necessary journal entries for these transactions in the city’s capital projects fund, debt service fund, and governmental activities at the government wide level. You may ignore related entries in the General Fund. Round all amounts to the nearest whole dollar.
a. On July 1, 2010, the first day of its fiscal year, the City of Chambers issued serial bonds with a face value totaling $5,000,000 and having maturities ranging from one to 20 years to make certain street and park improvements. The bonds were issued at 102 and bear interest of 5 percent per annum, payable semiannually on January 1 and July 1, with the first payment due on January 1, 2011. The first installment of principal in the amount of $250,000 is due on July 1, 2011. Premiums on bonds issued must be deposited directly in the debt service fund and be used for payment of bond interest. Premiums are amortized using the straight line method in the governmental activities journal but are not amortized in the debt service fund. Debt service for the serial bonds will be provided by a one quarter cent city sales tax imposed on every dollar of sales in the city.
(1) Record the FY 2011 budget for the Serial Bond Debt Service Fund, utilizing worksheets formatted as shown at the end of this problem. The city estimates that the sales tax will generate $440,000 in FY 2011. An appropriation needs to be provided only for the interest payment due on January 1, 2011.
(2) Record the issuance of the bonds, again utilizing your worksheets.
b. On August 2, 2010, the city entered into a $4,800,000 contract with Central Paving and Construction. Work on street and park improvement projects is expected to begin immediately and continue until August 2011.
c. On August 10, 2010, the capital project fund paid the city’s Utility Fund $42,000 for relocating power lines and poles to facilitate street widening. No encumbrance had been recorded for this service.
d. On August 20, 2010, the city’s Public Works Department billed the capital projects fund $30,000 for engineering and other design assistance. This amount was paid.
e. Street and park improvement sales taxes for debt service of $248,000 were collected in the six months ending December 31, 2010.
f. On January 1, 2011, the city mailed checks to bondholders for semiannual interest on the bonds.
g. On January 15, 2011, Central Paving and Construction submitted a billing to the city for $2,500,000. The city’s public works inspector agrees that all milestones have been met for this portion of the work.
h. On February 2, 2011, the city paid Central Paving and Construction the amount it had billed, except for 4 percent that was withheld as a retained percentage per terms of the contract.
i. During the six months ended June 30, 2011, sales tax collections for debt service amounted to $194,600.
j. Make all appropriate adjusting and closing entries at June 30, 2011, the end of the fiscal year. Based on authorization from the Public Works Department, $1,650,000 of construction work in progress was reclassified as infrastructure and another $250,000 was reclassified as improvements other than buildings. (Ignore closing entry for governmental activities.)
k. Reestablish the Encumbrances account balance in the capital projects fund effective July 1, 2011.
l. Record the FY 2012 budget for the debt service fund, assuming sales revenues are estimated at $492,000.
m. On July 1, 2011, the city mailed checks totaling $125,000 to all bondholders for semiannual interest and $250,000 to holders of record for bonds being redeemed.
n. On August 14, 2011, Central Paving and Construction submitted a final billing to the city for $2,300,000.
o. On August 23, 2011, the city paid the August 14 billing, except for a 4 percent retained percentage.
p. Upon final inspection by the Public Works Department, it was discovered that the contractor had failed to provide all required landscaping and certain other work for the street and park improvements. Public works employees completed this work at a total cost of $210,000. This amount was transferred to the General Fund using all retained cash and other cash of the capital projects fund.
q. The balance of the Construction Work in Progress account was reclassified as $150,000 to Improvements Other Than Buildings and the remainder to Infrastructure.
r. All remaining cash in the capital projects fund was transferred to the debt service fund and all accounts of the capital projects fund were closed.
Building Maintenance Fund. The balance sheet and statement of revenues, expenditures, and changes in fund balance for the Building Maintenance Fund, an internal service fund of Coastal City, are reproduced here. No further information about the nature or purposes of this fund is given in the annual report.
COASTAL CITY BUILDING MAINTENANCE FUND
Balance Sheet
As of December 31, 2011
Assets
Assets:
Cash and investments
$152,879
Accounts receivable
2,116
Inventory
779,000
Prepaid expenses
19,854
Total assets
$953,849
Liabilities and Fund Equity
Liabilities:
Accounts payable
$ 35,675
Other accrued liabilities
109,099
Accrued annual leave
227,369
Total liabilities
372,143
Fund equity:
Fund balance
581,706
Total liabilities and fund equity
$953,849
COASTAL CITY BUILDING MAINTENANCE FUND Statement of Revenues, Expenditures, and Changes in Fund Balance Year Ended December 31, 2011
Revenues:
Billings to departments
$10,774,781
Miscellaneous
100,344
Total billings
10,875,125
Expenditures:
Salaries and employee benefits
3,353,413
Supplies
3,409,096
Operating services and charges
495,143
Maintenance and repairs
3,536,443
Total expenditures
10,794,095
Excess of revenues over expenditures
81,030
Fund balance—January 1, 2011
500,676
Fund balance—December 31, 2011
$ 581,706
Required
a. Assuming that the Building Maintenance Fund is an internal service fund, discuss whether the financial information is presented in accordance with GASB standards.
b. If you were the manager of a city department that uses the services of the Building Maintenance Fund, what would you want to know in addition to the information disclosed in the financial statements?
Examine the CAFR. Utilizing the comprehensive annual financial report (CAFR) obtained for Exercise 1–1, follow these instructions:
a. Internal Service Funds.
(1) Use of Funds. What activities of the government are reported as being administered by internal service funds? (Note: Working capital funds, revolving funds, industrial funds, and intergovernmental service funds are other names used for funds of the type discussed in Chapter 7.) If internal service funds are not used by the reporting entity, does the report disclose how financing and accounting for activities such as purchasing, motor pools, printing, data processing, and other activities commonly used by more than one fund are handled? Does the report state the basis of accounting used for the internal service funds? Is the accounting for all funds in this category on the same basis? If so, is the financial statement presentation consistent with the stated basis? If the basis of accounting is not stated, analyze the statements to determine which basis is used—accrual, modified accrual, or cash basis.
(2) Fund Disclosure. In the balance sheet(s) or statement(s) of net assets displaying information for the internal service fund(s), are assets classified in accord with practices of profit seeking businesses, or are current, capital, and other assets not separately displayed? If there are receivables other than from other funds or other governments, are allowances for estimated un collectibles provided? Are allowances for depreciation deducted from related capital asset accounts? Are current liabilities and long term debt properly distinguished in the balance sheet? Are long term loans from other funds properly distinguished from capital contributions received from other funds? Are budgetary accounts (Estimated Revenues, Appropriations, Encumbrances) used by the internal service funds? From what sources were revenues actually obtained by each internal service fund? How are costs and expenses of each fund classified? Are noncash expenses, such as depreciation, separately disclosed? Do the revenues of each fund exceed the costs and expenses of the period? Compute the net income (or net loss) of each fund in this category as a percentage of its operating revenue for the period. Does the net income (or net loss) for any fund exceed 5 percent of operating revenues? If so, do the statements or the accompanying notes explain how the excess is being used or how the deficiency is being financed?
(3) Statement of Cash Flows. Is a statement of cash flows presented for internal service funds? If so, how does the cash provided by operations shown in this statement relate to the revenues and expenses shown in the statement of revenues, expenses, and changes in net assets, or other similarly titled operating statement? Are cash flows from financing activities presented separately for noncapital and capital related activities? Is there a section for cash flows from investing activities?
(4) Government wide Financial Statements. Is there a column for business type activities on the statement of net assets and statement of activities? Is there any evidence that the internal service fund account balances were collapsed into the Governmental Activities column? If enterprise funds are the predominant participants in the internal service fund, do you see evidence that the internal service fund balances are reported in the Business type Activities column of the government wide statements?
b. Enterprise Funds.
(1) Use of Funds. What activities of the government are reported as being administered by enterprise funds? Does the government own and operate its water utility? Electric utility? Gas utility? Transportation system? Are combining statements presented in the financial section of the CAFR for all enterprise funds, or are separate statements presented for each enterprise fund? Do all enterprise funds use accrual accounting? Are all funds in this category earning revenues at least equal to costs and expenses? If not, how is the operating deficit being financed? What sources furnished the original investment in fund assets? Do the notes include segment information on individual enterprise funds where applicable? Are sales to other funds or other governments separately disclosed? Are there receivables from other funds or other governments? How are receivables from component units, if any, disclosed? Is there any evidence that enterprise funds contribute amounts to the General Fund in lieu of taxes to help support services received by the enterprise? Is there any evidence that enterprise funds make excessively large contributions to the General Fund or any other funds?
(2) Utility Funds. Is it possible to tell from the report whether utilities of this government are subject to the same regulations as investor owned utilities in the same state? (If the utility statements use account titles prescribed by the NARUC and the FERC, as described in this chapter, there is a good chance that the governmentally owned utilities are subject to at least some supervision by a state regulatory agency.) What rate of return on sales (or operating revenues) is being earned by each utility fund? What rate of return on total assets is being earned by each utility fund? Is depreciation taken on the utility plant? Are accounting policies and accounting changes properly disclosed? If so, what method of depreciation
is being used? Does each utility account for its own debt service and construction activities in the manner described in this chapter? What special funds or restricted assets are utilized by each utility?
(3) Nonutility Enterprise Funds. Is the accounting for nonutility enterprise funds the same as investor owned enterprises in the same industries? (In order to answer this, you may need to refer to publications of trade associations or to handbooks or encyclopedias of accounting systems found in business libraries.) If you cannot find information about investor owned counterparts of the governmental nonutility enterprise funds, do the statements of the latter provide evidence that generally accepted accounting principles devised for profit seeking businesses were used?
(4) Government wide Financial Statements. What proportion of the net assets of the business type activities are reported as invested in capital assets, restricted, and unrestricted? Were the business type activities profitable; that is, did revenues exceed expenses?
(Cost accumulation in two departments) Country Products manufactures quilt racks. Pine is introduced in Department 1, where the raw material is cut and assembled. In Department 2, completed racks are stained and packaged for shipment. Department 1 applies overhead on the basis of machine hours; Department 2 applies overhead on the basis of direct labor hours. The company’s predetermined overhead rates were computed using the following information:
Department 1
Department 2
Expected overhead
$465,000
$380,600
Expected DLHs
4,000
22,000
Expected MHs
30,000
2,500
Sue Power contacted Country Products to produce 500 quilt racks as a special order. Power wanted the racks made from teak and to be made larger than the company’s normal racks. Country Products designated Power’s order as Job #462.
During July, Country Products purchased $346,000 of raw material on account, of which $19,000 was teak. Requisitions were issued for $340,000 of raw material, including all the teak. There were 285 direct labor hours worked (at a rate of $11 per DLH) and 2,400 machine hours recorded in Department 1; of these hours, 25 DLHs and 320 MHs were on Job #462. Department 2 had 1,430 DLHs (at a rate of $18 per DLH) and 180 MHs; of these, 158 DLHs and 20 MHs were worked on Job #462.Assume that all wages are paid in cash.
Job #462 was completed on July 28 and shipped to Power. She was billed cost plus 20 percent.
a. What are the predetermined overhead rates for Departments 1 and 2?
b. Prepare journal entries for the July transactions.
c. What were the cost and selling price per unit of Job #462? What was the cost per unit of the raw material?
d. Assume that enough pine had been issued in July for 20,000 quilt racks. The RM inventory manager is a friend of Power and he conveniently “forgot” to trace the cost of the teak specifically to Job #462. What would have been the effect of this error on the raw material cost, total cost, and selling price for each unit in Job #462?
(Standard costing; writing) Routine maintenance services are provided by Latamore Industries to oil and gas firms in their production facilities. Although many of the client services are relatively unique, some services are repetitive. The firm individually negotiates prices with each client. The CFO of Latamore Industries recently examined the profitability of a sample of the firm’s service contracts and was surprised that contract profit amounts varied significantly. Additionally, production inputs (such as material and labor) often varied substantially from those budgeted at the time the service contracts were negotiated. The CFO has asked you, as a company intern, to write a memo describing how the adoption of standard costing could improve cost control and profit management for the firm’s service contracts.
(Standard costing) Weingold Inc. engages in routine and customer print jobs for customers. In November 2010, a client specified the use of one of the company’s standard papers for a large job, but asked for a high level of customization relative to the print design. Thus, standard costs could be used for material but not for labor. The following direct material costs were incurred for the client’s job:
Actual unit purchase price
$0.032 per sheet
Standard unit price
$0.036 per sheet
Quantity purchased and used in November
980,000 sheets
Standard quantity allowed for good production
984,000 sheets
Calculate the material price variance and the material quantity variance for the client’s job.
(Standard costing) Harvey Inc. uses a standard cost system for labor. Standard costs for material cannot be used because customers require unique materials and all jobs are different sizes. One of the company’s jobs experienced the following results related to direct labor in December 2010:
Actual hours worked
9,000
Standard hours for production
8,600
Actual direct labor rate
$9.65
Standard direct labor rate
$9.85
a. Calculate the total actual payroll.
b. Determine the labor rate variance.
c. Determine the labor quantity variance.
d. What concerns do you have about the variances in (b) and (c)?
(Job costing and decision making; writing) Bonivo Inc. manufactures computers from commodity components to client specifications. The company has his torically tracked only the cost of components to computers, and computer selling prices, or bids, have been based solely on the cost of components plus a markup sufficient to cover the other operating costs. In recent years, the company has encountered increasing price pressure from customers and, as a result, computers have often been sold at less than the full markup price—causing continually decreasing profits for the firm.
As you have provided other financial services to Bonivo Inc. in the past, company management has asked you for guidance regarding approaches that could be taken to better manage the firm’s profits and prices. You decide that a job order costing system could be helpful to Bonivo.
a. Explain how a job order costing system could help Bonivo better control costs and profits.
b. Explain why Bonivo should not base computer prices only on component costs plus a markup.
(Cost control; writing) Juneau Container makes steel storage canisters for various chemical products. The company uses a job order costing system and obtains jobs based on competitive bidding. For each project, a budget is developed.
One of the firm’s products is a 55 gallon drum. In the past year, the company made this drum on four separate occasions for four different customers. Financial details for the four orders follow:
Date
Job No.
Quantity
Bid Price
Budgeted Cost
Actual Cost
Jan. 17
2118
60,000
$190,000
$120,000
$145,000
Mar. 13
2789
29,000
155,000
110,000
121,000
Oct. 20
4300
61,000
180,000
125,000
143,000
Dec. 3
4990
35,000
175,000
150,000
168,000
Assume that you are the company’s controller. Write a memo to management describing any problems that you perceive in the data presented and the steps that should be taken to eliminate recurrence of these problems.
(Cost control; ethics; writing) Companies use time sheets for two primary reasons: to know how many hours an employee works and, in a job order production situation, to trace work hours to products. An article (“Altering of Worker Time Cards Spurs Growing Number of Suits” by Steven Greenhouse) in the New York Times on April 4, 2004, described a recent corporate practice of deleting worker hours to increase organizational profitability. Use your library database to obtain this article and discuss the following: Ethics
a. What companies were mentioned as having been found to engage in this practice?
b. Why is it easier now than in the past to engage in this practice?
c. As a member of upper management, how would you respond to finding out that this practice was being used in some of your stores? Provide an answer that addresses both the short run and the long run.
(Job order costing; rework) San Angelo Corp. uses a job order costing system for client contracts related to custom manufactured pulley systems. Elmore Mechanical recently ordered 20,000 pulleys, and the job was assigned #BA468. Information for Job #BA468 revealed the following:
Direct material
$40,800
Direct labor
49,200
Overhead
36,800
Final inspection of the pulleys revealed that 230 were defective. In correcting the defects, an additional $1,150 of cost was incurred ($250 for direct material and $900 for direct labor). After the defects were corrected, the pulleys were included with the other good units and shipped to the customer.
a. Journalize the entry to record incurrence of the rework costs if San Angelo Corp.’s predetermined overhead rate includes normal rework costs.
b. Journalize the entry to record incurrence of the rework costs if rework is normal but specific to this job. If San Angelo Corp. prices jobs on a cost plus basis, should the rework costs be considered in determining the markup?
c. Journalize the entry to record incurrence of the rework costs, assuming that all rework is abnormal.
(Job order costing; rework) Canyon City Co. uses a job order costing system that combines actual direct material and actual direct labor costs with a predetermined overhead charge based on machine hours. Expected overhead and machine hours of $1,421,000 and 145,000, respectively, were used in developing the predetermined rate for 2010.
During 2010, the company worked on Job #876 and incurred the following costs and machine hours:
Direct material
$47,500
Direct labor
21,800
Machine hours
325
a. What is the total cost of Job #876? What is the cost per unit if 1,500 units were made? (Round to the nearest cent.)
b. In completing Job #876, 30 units were defective and had to be reworked at a cost of $25 each. Assume that spoilage and rework costs were included in the original estimated overhead costs. Where does the $750 rework cost appear in the accounts of Canyon City Co.?
c. Disregard the facts in (b). Upon completing Job #876, the quality control inspector determined that 30 units were spoiled and would be unacceptable to the customer. Thirty additional good units were made at a total cost of $1,390. The spoiled units were sold for $240 as “seconds” to an outlet store. What is the total cost of Job #876?
(Journal entries) Polaski Inc. uses an actual cost, job order system. The following transactions are for August 2010. At the beginning of the month, Direct Material Inventory was $2,000, Work in Process Inventory was $10,500, and Finished Goods Inventory was $6,500.
Direct material purchases on account totaled $90,000.
Direct labor cost for the period totaled $75,600 for 8,000 direct labor hours; these costs were paid in cash.
Actual overhead costs were $82,000 and are applied to production.
The ending inventory of Direct Material Inventory was $3,500.
The ending inventory of Work in Process Inventory was $7,750.
Goods costing $243,700 were sold for $350,400 cash.
a. What was the actual OH rate per direct labor hour?
b Journalize the preceding transactions.
c. Determine the ending balance in Finished Goods Inventory.
(Journal entries; cost accumulation) Stockman Co. began 2010 with three jobs in process:
TYPE OF COST
Job No.
Direct Material
Direct Labor
Overhead
Total
247
$ 77,200
$ 91,400
$ 36,560
$ 205,160
251
176,600
209,800
83,920
470,320
253
145,400
169,600
67,840
382,840
Totals
$399,200
$470,800
$188,320
$1,058,320
During 2010, the following transactions occurred:
1. The firm purchased and paid for $542,000 of raw material.
2. Factory payroll records revealed the following:
Indirect labor incurred was $54,000.
Direct labor incurred was $602,800 and was associated with the jobs as follows:
Job No.
Direct Labor Cost
247
$ 17,400
251
8,800
253
21,000
254
136,600
255
145,000
256
94,600
257
179,400
3. Material requisition forms issued during the year revealed the following:
Indirect material issued totaled $76,000.
Direct material issued totaled $466,400 and was associated with jobs as follows:
Job No.
Direct Material Cost
247
$ 12,400
251
6,200
253
16,800
254
105,200
255
119,800
256
72,800
257
133,200
4. Overhead is applied to jobs on the basis of direct labor cost. Management budgeted overhead of $240,000 and total direct labor cost of $600,000 for 2010. Actual total factory overhead costs (including indirect labor and indirect material) for the year totaled $244,400.
5. Jobs #247 through #255 were completed and delivered to customers, who paid for the goods in cash. The revenue on these jobs was $2,264,774.
a. Journalize all preceding events.
b. Determine the ending balances for the jobs still in process.
c. Determine the cost of jobs sold, adjusted for underapplied or overapplied overhead.
(Simple inventory calculation) Production data for the first week in November 2010 for Florida Fabricators were as follows:
WORK IN PROCESS INVENTORY
Date
Job No.
Material
Labor
Machine Time (Overhead)
Nov. 1
411
$1,900
36 hours
50 hours
1
412
1,240
10 hours
30 hours
7
417
620
8 hours
16 hours
Finished Goods Inventory, Nov. 1: $23,800
Finished Goods Inventory, Nov. 5: $0
MATERIAL RECORDS
Type
Inv. 11/1
Purchases
Issuances
Inv. 11/5
Aluminum
$ 8,300
$98,300
$58,700
$ ?
Steel
12,800
26,500
34,200
$ ?
Other
5,800
23,550
25,900
$ ?
Direct labor hours worked in the first week of November were 680 at a cost of $15 per direct labor hour. Machine hours worked that week were 1,200. Overhead for first week in November was as follows:
Depreciation
$ 9,000
Supervisor salaries
14,400
Indirect labor
8,350
Insurance
2,800
Utilities
2,250
Total
$36,800
Overhead is applied to production at a rate of $30 per machine hour. Underapplied or overapplied overhead is treated as an adjustment to Cost of Goods Sold at year end. All company jobs are consecutively numbered, and all work not in ending Finished Goods Inventory has been completed and sold. The only job in progress on November 5 was #417.
(Job cost sheet analysis) You have applied for a cost accounting position with Chelsea Containers. The company controller has asked all candidates to take a quiz to demonstrate their knowledge of job order costing. Chelsea’s job order costing system is based on normal costs, and overhead is applied based on direct labor cost. The following information pertaining to May has been provided to you:
Direct
Applied
Job No.
Material
Direct Labor
Overhead
Total Cost
67
$ 35,406
$13,840
$15,916
$ 65,162
69
109,872
14,480
16,652
141,004
70
2,436
4,000
4,600
11,036
71
308,430
57,000
?
?
72
57,690
4,400
5,060
67,150
You are informed that Job #68 had been completed in April. You are also told that Job #67 was the only job in process at the beginning of May. At that time, the job had been assigned $25,800 for direct material and $7,200 for direct labor. At the end of May, Job #71 had not been completed; all others were complete. Answers to the following questions are required:
a. What is Chelsea Containers’ predetermined overhead rate?
b. What was the total cost of beginning Work in Process Inventory?
c. What were total direct manufacturing costs incurred for May?
(Comprehensive) Birmingham Contractors uses a job order costing system. In May 2010, the company made a $3,300,000 bid to build a pedestrian overpass over the beach highway at Gulf Shores, Alabama. Birmingham Contractors won the bid and assigned #515 to the project. Its completion date was set at December 15, 2010. The following costs were estimated for completion of the overpass: $1,240,000 for direct material, $670,000 for direct labor, and $402,000 for overhead.
During July, work began on job #515; direct material cost assigned to Job #515was $121,800, and direct labor cost associated with it was $175,040. The firm uses a predetermined OH rate of 60 percent of direct labor cost. Birmingham Contractors also worked on several other jobs during July and incurred the following costs:
Direct material (including Job #515) issued
$579,300
Direct labor (including Job #515) accrued
584,000
Indirect labor accrued
55,800
Administrative salaries and wages accrued
39,600
Depreciation on construction equipment
26,400
Depreciation on office equipment
7,800
Client entertainment (on accounts payable)
11,100
Advertising for firm (paid in cash)
6,600
Indirect material (from supplies inventory)
18,600
Miscellaneous expenses (design related; to be paid in the following month)
10,200
Accrued utilities (for office, $1,800; for construction, $5,400)
7,200
During July, Birmingham Contractors completed several jobs that had been in process before the beginning of the month. These completed jobs sold for $1,224,000 and payment will be made to the company in August. The related job cost sheets showed costs associated with those jobs of $829,000. At the beginning of July, Birmingham Contractors had Work in Process Inventory of $871,800.
a. Prepare a job order cost sheet for Job #515, including all job details, and post the appropriate cost information for July.
b. Prepare journal entries for the preceding information.
c. Prepare a Cost of Goods Manufactured Schedule for July for Birmingham Contractors.
d. Assuming that the company pays income tax at a 40 percent rate, prepare an income statement for Birmingham Contractors.
(Comprehensive) Edward Nabors owns Enclose, which designs and manufactures perimeter fencing for large retail and commercial buildings. Each job goes through three stages: design, production, and installation. Three jobs were started and completed during the first week of May 2010. No jobs were in process at the end of April 2010. Information for the three departments for the first week in May follows.
DEPARTMENT
Job #2019
Design
Production
Installation
Direct labor hours
800
NA
760
Machine hours
NA
720
NA
Direct labor cost
$81,600
$34,000
$10,080
Direct material
$9,600
$116,400
$10,400
Job #2020
Design
Production
Installation
Direct labor hours
680
NA
640
Machine hours
NA
2,400
NA
Direct labor cost
$69,360
$59,600
$11,520
Direct material
$8,200
$268,800
$36,800
Job #2021
Design
Production
Installation
Direct labor hours
720
NA
3,280
Machine hours
NA
960
NA
Direct labor cost
$73,440
$21,600
$15,200
Direct material
$17,600
$232,000
$10,400
Overhead is applied using departmental rates. Design and Installation use direct labor cost as the base, with rates of 30 and 90 percent, respectively. Production uses machine hours as the base, with a rate of $15 per hour. Actual overhead for the month was $105,600 in Design, $60,000 in Production, and $31,200 in Installation.
a. Determine the overhead to be applied to each job. By how much is the overhead underapplied or overapplied in each department? For the company?
b. Assume that no journal entries have been made to Work in Process Inventory. Journalize all necessary entries to both the subsidiary ledger and general ledger accounts. Accrue direct labor costs.
(Cost accumulation; assigning costs to jobs) Gigi LeBlanc is an advertising consultant who tracks costs for her jobs using a job order costing system. During September, LeBlanc and her staff worked on and completed jobs for the following companies:
Reliant
Dumas
Company
Manufacturing
Omaha Inc.
Direct material cost
$7,800
$14,200
$19,800
Direct labor cost
$5,580
$18,000
$28,350
Number of promotions designed
3
10
8
Direct material can be traced to each job because these costs are typically associated with specific advertising campaigns. Based on historical data, LeBlanc has calculated an overhead charge of $58 per direct labor hour. The normal labor cost per hour is $45.
a. Determine the total cost for each of the advertising accounts for the month.
b. Determine the cost per promotion developed for each client. (Round to the nearest dollar.)
c. LeBlanc charges $8,600 per promotion. What was her net income for the month, assuming actual overhead for the month was $50,000? Adjust for under or overapplied overhead.
d. You suggest to LeBlanc that she bill ads on a cost plus basis and suggest a markup of30 percent on cost. How would her income have compared to her income computed in (c) if she had used this method? How would her clients feel about such a method?
(Comprehensive; job cost sheet) Lincoln Construction Company buildsbridges. In October and November 2010, the firm worked exclusively on a bridge spanning the Calamus River in northern Nebraska. Lincoln Construction’s Precast Department builds structural elements of the bridges in temporary plants located near the construction sites. The Construction Department operates at the bridge site and assembles the precast structural elements. Estimated costs for thalamus River bridge for the Precast Department were $1,550,000 for direct material, $220,000 for direct labor, and $275,000 for overhead. For the Construction Department, estimated costs for the Calamus River bridge were $350,000 for direct material, $130,000 for direct labor, and $214,500 for overhead. Overhead is applied on the last day of each month. Overhead application rates for the Precast and Construction departments are $25 per machine hour and 165 percent of direct labor cost, respectively.
TRANSACTIONS FOR OCTOBER
1
Purchased $1,150,000 of material (on account) for the Precast Department to begin building structural elements. All of the material was issued to production; of the issuances, $650,000 was considered direct.
5
Installed utilities at the bridge site at a total cost of $25,000. This amount will be paid at a later date.
8
Paid rent for the temporary construction site housing the Precast Department, $5,000.
15
Completed bridge support pillars by the Precast Department and transferred to the construction site.
20
Paid machine rental expense of $60,000 incurred by the Construction Department for clearing the bridge site and digging foundations for bridge supports.
24
Purchased additional material costing $1,485,000 on account.
31
Paid the following bills for the Precast Department: utilities, $7,000; direct labor, $45,000; insurance, $6,220; and supervision and other indirect labor costs, $7,900. Departmental depreciation was recorded, $15,200. The company also paid bills for the Construction Department: utilities, $2,300; direct labor, $16,300; indirect labor, $5,700; and insurance, $1,900. Departmental depreciation was recorded on equipment, $8,750.
31
Issued a check to pay for the material purchased on October 1 and October 24.
31
Applied overhead to production in each department; 6,000 machine hours were worked in the Precast Department in October.
TRANSACTIONS FOR NOVEMBER
1
Transferred additional structural elements from the Precast Department to the construction site. The Construction Department incurred a cash cost of $5,000 to rent a crane.
4
Issued $1,000,000 of material to the Precast Department. Of this amount, $825,000 was considered direct.
8
Paid rent of $5,000 in cash for the temporary site occupied by the Precast Department.
15
Issued $425,000 of material to the Construction Department. Of this amount, $200,000 was considered direct.
18
Transferred additional structural elements from the Precast Department to the construction site.
24
Transferred the final batch of structural elements from the Precast Department to the construction site.
29
Completed the bridge.
30
Paid final bills for the month in the Precast Department: utilities, $15,000; direct labor, $115,000; insurance, $9,350; and supervision and other indirect labor costs, $14,500. Depreciation was recorded, $15,200. The company also paid bills for the Construction Department: utilities, $4,900; direct labor, $134,300; indirect labor, $15,200; and insurance, $5,400. Depreciation was recorded on equipment, $18,350.
30
Applied overhead in each department. The Precast Department recorded 3,950 machine
hours in November.
30
Billed the state of Nebraska for the completed bridge at the contract price of $3,450,000.
a. Journalize the entries for the preceding transactions. For purposes of this problem, it is not necessary to transfer direct material and direct labor from one department to the other.
b. Post all entries to T accounts.
c. Prepare a job order cost sheet, which includes estimated costs, for the construction of the bridge.
d. Discuss Lincoln Construction Company’s estimates relative to its actual costs.
(Comprehensive) Pip Squeaks Inc. is a manufacturer of furnishings for infants and children. The company uses a job order cost system. Pip Squeaks’ Work in Process Inventory on April 30, 2010, consisted of the following jobs:
Job No.
Items
Units
Accumulated Cost
CBS102
Cribs
20,000
$ 900,000
PLP086
Playpens
15,000
420,000
DRS114
Dressers
25,000
1,570,000
The company’s Finished Goods Inventory, carried on a FIFO (first in, first out) basis, consists of five items:
Item
Quantity and Unit Cost
Total Cost
Cribs
7,500 units _ $64
$ 480,000
Strollers
13,000 units _ $23
299,000
Carriages
11,200 units _ $102
1,142,400
Dressers
21,000 units _ $55
1,155,000
Playpens
19,400 units _ $35
679,000
Total
$3,755,400
Pip Squeaks applies factory overhead on the basis of direct labor hours. The company’s factory overhead budget for the fiscal year ending May 31, 2010, totaled $4,500,000, and the company planned to work 600,000 direct labor hours during this year. Through the first 11 months of the year, a total of 555,000 direct labor hours were worked, and total factory overhead amounted to $4,273,500.
At the end of April, the balance in Pip Squeaks’ Raw Material Inventory account, which includes both raw material and purchased parts, was $668,000.Additions to and requisitions from the material inventory during May included the following:
Raw Material
Parts Purchased
Additions
$242,000
$396,000
Requisitions:
Job #CBS102
51,000
104,000
Job #PLP086
3,000
10,800
Job #DRS114
124,000
87,000
Job #STR077 (10,000 strollers)
62,000
81,000
Job #CRG098 (5,000 carriages)
65,000
187,000
During May, Pip Squeaks’ factory payroll consisted of the following:
Job No.
Hours
Cost
CBS102
12,000
$122,400
PLP086
4,400
43,200
DRS114
19,500
200,500
STR077
3,500
30,000
CRG098
14,000
138,000
Indirect
3,000
29,400
Supervision
57,600
Total
$621,100
The jobs that were completed in May and the unit sales for May are as follows:
Job No.
Items
Quantity Completed
CBS102
Cribs
20,000
PLP086
Playpens
15,000
STR077
Strollers
10,000
CRG098
Carriages
5,000
Items
Quantity Shipped
Cribs
17,500
Playpens
21,000
Strollers
14,000
Dressers
18,000
Carriages
6,000
a. Describe when it is appropriate for a company to use a job order costing system.
b. Calculate the dollar balance in Pip Squeaks’ Work in Process Inventory account as of May 31, 2010.
c. Calculate the dollar amount related to the playpens in Pip Squeaks’ Finished Goods Inventory as of May 31, 2010.
d. Explain the treatment of underapplied or overapplied overhead when using a job order costing system.
(Missing amounts) Riveredge Manufacturing Company realized too late that it had made a mistake locating its controller’s office and its electronic data processing system in the basement. Because of the spring thaw, the Mississippi River overflowed its banks on May 2 and flooded the company’s basement. Electronic data storage was destroyed, and the company had not provided off site storage of data. Some of the paper printouts were located but were badly faded and only partially legible. On May 3,when the flooding subsided, company accountants were able to assemble the following factory related data from the debris and from discussions with various knowledgeable personnel. Data about the following accounts were found:
Raw Material (includes indirect material) Inventory: Balance April 1 was $9,600.
Work in Process Inventory: Balance April 1 was $15,400.
Finished Goods Inventory: Balance April 30 was $13,200.
Total company payroll cost for April was $58,400.
Accounts payable balance April 30 was $36,000.
Indirect material used in April cost $11,600.
Other nonmaterial and nonlabor overhead items for April totaled $5,000.
Payroll records, kept at an across town service center that processes the company’s payroll, showed that April’s direct labor amounted to $36,400 and represented 8,800 labor hours. Indirect factory labor amounted to $10,800 in April.
The president’s office had a file copy of the production budget for the current year. It revealed that the predetermined overhead application rate is based on planned annual direct labor hours of 100,800 and expected factory overhead of $302,400.
Discussion with the factory superintendent indicated that only two jobs remained unfinished on April 30. Fortunately, the superintendent also had copies of the job cost sheets that showed a combined total of $4,800 of direct material and $9,000 of direct labor. The direct labor hours on these jobs totaled 2,144. Both of these jobs had been started during April.
A badly faded copy of April’s Cost of Goods Manufactured and Sold Schedule showed cost of goods manufactured was $96,000, and the April 1 Finished Goods Inventory was $16,800.
The treasurer’s office files copies of paid invoices chronologically. All invoices are for raw material purchased on account. Examination of these files revealed that unpaid invoices on April 1 amounted to $12,200; $56,000 of purchases had been made during April; and $36,000 of unpaid invoices existed on April 30.
a. Calculate the cost of direct material used in April.
b. Calculate the cost of raw material issued in April.
c. Calculate the April 30 balance of Raw Material Inventory.
d. Determine the amount of underapplied or overapplied overhead for April.
(Standard costing) Modern Convenience specializes in making robotic conveyor systems to move materials within a factory. Model #89 accounts for approximately 60 percent of the company’s annual sales. Because the company has produced and expects to continue to produce a significant quantity of this model, Modern Convenience uses the following standard costs to account for Model #89 production
Direct material (28,000 pounds)
$ 56,000
Direct labor (1,720 hours at $20 per hour)
34,400
Overhead
76,000
Total standard cost
$166,400
For the 200 units of Model #89 produced in 2010, the actual costs were
Direct material (6,000,000 pounds)
$11,600,000
Direct labor (178,400 hours)
6,957,600
Overhead
14,800,000
Total actual cost
$33,357,600
a. Compute a separate variance between actual and standard cost for direct material, direct labor, and manufacturing overhead for the Model #89 units produced in 2010.
b. Is the direct material variance found in (a) driven primarily by the price per pound difference between standard and actual or the quantity difference between standard and actual? Explain.
5 Individual transactions often have a significant impact on ratios. This problem will consider the direction of such an impact.
Ratio Transaction
Times Interest Earned
Debt Ratio
Debt/Equity Ratio
Debt to Tangible Net Worth
a. Purchase of buildings financed by mortgage.
b. Purchase of inventory on short term
loan at 1% over prime rate.
c. Declaration and payment of cash dividend.
d. Declaration and payment of stock dividend.
e. Firm increases profits by cutting cost of sales.
f. Appropriation of retained earnings.
g. Sale of common stock.
h. Repayment of long term bank loan.
i. Conversion of bonds to common stock outstanding.
j. Sale of inventory at greater than cost.
Required Indicate the effect of each of the transactions on the ratios listed. Use þ to indicate an increase, _ to indicate a decrease, and 0 to indicate no effect. Assume an initial times interest earned of more than 1, and a debt ratio, debt/equity ratio, and a total debt to tangible net worth of less than 1.
Mr. Parks has asked you to advise him on the long term debt paying ability of Arodex Company. He provides you with the following ratios:
2009
2008
1
Times interest earned
8.2
6
5.5
Debt ratio
40%
39%
40%
Debt to tangible net worth
80%
81%
81%
Required
a. Give the implications and the limitations of each item separately and then the collective influence that could be drawn from them about Arodex Company’s long term debt position.
b. What warnings should you offer Mr. Parks about the limitations of ratio analysis for the purpose stated here?
For the year ended June 30, 2009, A.E.G. Enterprises presented the financial statements. Early in the new fiscal year, the officers of the firm formalized a substantial expansion plan. The plan will increase fixed assets by $190 million. In addition, extra inventory will be needed to support expanded production. The increase in inventory is purported to be $10 million.
The firm’s investment bankers have suggested the following three alternative financing plans:
Plan A: Sell preferred stock at par, 5%.
Plan B: Sell common stock at $10 per share.
Plan C: Sell long term bonds, due in 20 years, at par ($1,000), with a stated interest rate of 8%.
A.E.G. ENTERPRISES Balance Sheet for June 30, 2009 (in thousands)
Common stock ($1 par, 200,000,000 shares authorized, 100,000,000 issued)
100,000
Premium on common stock
120,000
Retained earnings
137,000
Total liabilities and stockholders’ equity
$600,000
A.E.G. ENTERPRISES Income Statement For the Year Ended June 30, 2009 (in thousands except earnings per share)
Sales
$936,000
Cost of sales
671,000
Gross profit
$265,000
Operating expenses:
Selling
$62,000
General
41,000
103,000
Operating income
$162,000
Other items:
Interest expense
20,000
Earnings before provision for income tax
$142,000
Provision for income tax
56,800
Net income
$85,200
Earnings per share
$0.83
Required
a. For the year ended June 30, 2009, compute:
1. Times interest earned
2. Debt ratio
3. Debt/equity ratio
4. Debt to tangible net worth ratio
b. Assuming the same financial results and statement balances, except for the increased assets and financing, compute the same ratios as in (a) under each financing alternative. Do not attempt to adjust retained earnings for the next year’s profits.
c. Changes in earnings and number of shares will give the following earnings per share: Plan A— 0.73, Plan B—0.69, and Plan C—0.73. Based on the information given, discuss the advantages and disadvantages of each alternative.
d. Why does the 5% preferred stock cost the company more than the 8% bonds?
Required Answer the following multiple choice questions:
a. Which of the following ratios can be used as a guide to a firm’s ability to carry debt from an income perspective?
1. Debt ratio
2. Debt to tangible net worth
3. Debt/equity
4. Times interest earned
5. Current ratio
b. There is disagreement on all but which of the following items as to whether it should be considered a liability in the debt ratio?
1. Short term liabilities
2. Reserve accounts
3. Deferred taxes
4. Non controlling income (loss)
5. Preferred stock
c. A firm may have substantial liabilities that are not disclosed on the face of the balance sheet from all but which of the following?
1. Leases
2. Pension plans
3. Joint ventures
4. Contingencies
5. Bonds payable
d. In computing the debt ratio, which of the following is subtracted in the denominator?
1. Copyrights
2. Trademarks
3. Patents
4. Marketable securities
5. None of the above
e. All but which of these ratios are considered to be debt ratios?
1. Times interest earned
2. Debt ratio
3. Debt/equity
4. Fixed charge ratio
5. Current ratio
f. Which of the following statements is false?
1. The debt to tangible net worth ratio is more conservative than the debt ratio.
2. The debt to tangible net worth ratio is more conservative than the debt/equity ratio.
3. Times interest earned indicates an income statement view of debt.
4. The debt/equity ratio indicates an income statement view of debt.
5. The debt ratio indicates a balance sheet view of debt.
g. Sneider Company has long term debt of $500,000, while Abbott Company has long term debt of $50,000. Which of the following statements best represents an analysis of the long term debt position of these two firms?
1. Sneider Company’s times interest earned should be lower than Abbott Company’s.
2. Abbott Company’s times interest earned should be lower than Sneider Company’s.
3. Abbott Company has a better long term borrowing ability than does Sneider Company.
4. Sneider Company has a better long term borrowing ability than does Abbott Company.
5. None of the above
h. A times interest earned ratio of 0.20 to 1 means
1. That the firm will default on its interest payment.
2. That net income is less than the interest expense (including capitalized interest).
3. That cash flow exceeds the net income.
4. That the firm should reduce its debt.
5. None of the above
i. In computing debt to tangible net worth, which of the following is not subtracted in the denominator?
1. Patents
2. Goodwill
3. Land
4. Bonds payable
5. Both 3 and 4
j. The ratio fixed charge coverage
1. Is a cash flow indication of debt paying ability.
2. Is an income statement indication of debt paying ability.
3. Is a balance sheet indication of debt paying ability.
4. Will usually be higher than the times interest earned ratio.
5. None of the above
k. Under the Employee Retirement Income Security Act, a company can be liable for its pension plan up to
1. 30% of its net worth.
2. 30% of pension liabilities.
3. 30% of liabilities.
4. 40% of its net worth.
5. None of the above
l. Which of the following statements is correct?
1. Capitalized interest should be included with interest expense when computing times interest earned.
2. A ratio that indicates a firm’s long term debt paying ability from the balance sheet view is the times interest earned.
3. Some of the items on the income statement that are excluded in order to compute times interest earned are interest expense, income taxes, and interest income.
4. Usually, the highest times interest coverage in the most recent five year period is used as the primary indication of the interest coverage.
5. None of the above
m. Which of these items does not represent a definite commitment to pay out funds in the future?
THE GEO GROUP, INC.* CONSOLIDATED STATEMENTS OF INCOME Fiscal Years Ended December 28, 2008, December 30, 2007, and December 31, 2006
2008
2007
2006
(In thousands, except per share data)
Revenues
$1,043,006
$976,299
$818,439
Operating Expenses
822,053
787,862
679,886
Depreciation and Amortization
37,406
33,218
21,682
General and Administrative Expenses
69,151
64,492
56,268
Operating Income
114,396
90,727
60,603
Interest Income
7,045
8,746
10,687
Interest Expense
30,202
36,051
28,231
Write off of Deferred Financing Fees from Extinguishment of Debt
4,794
1,295
Income before Income Taxes, Minority Interest, Equity in Earnings of Affiliates, and Discontinued Operations
91,239
58,628
41,764
Provision for Income Taxes
34,033
22,293
15,215
Minority Interest
376
397
125
Equity in Earnings of Affiliates, net of income tax (benefit) provision of ($805), $1,030, and $56
4,623
2,151
1,576
Income from Continuing Operations
61,453
38,089
28,000
Income (loss) from Discontinued Operations, net of tax provision of $236, $2,310, and $1,139
2,551
3,756
2,031
Net Income
$58,902
$41,845
$30,031
Weighted Average Common Shares Outstanding:
Basic
50,539
47,727
34,442
Diluted
51,830
49,192
35,744
Earnings (loss) per Common Share:
Basic:
Income from continuing operations
$1.22
$0.80
$0.81
Income (loss) from discontinued operations
0.05
0.08
0.06
Net income per share —basic
$1.17
$0.88
$0.87
Diluted:
Income from continuing operations
$1.19
$0.77
$0.78
Income (loss) from discontinued operations
0.05
0.08
0.06
Net income per share —diluted
$1.14
$0.85
$0.84
4. Property and Equipment (in Part)
Property and equipment consist of the following at fiscal year end:
Useful Life (Years)
2008
2007
(In thousands)
Land
—
$49,686
$43,340
Buildings and improvements
2 to 40
765,103
635,809
Leasehold improvements
1 to 15
68,845
57,737
Equipment
3 to 10
55,007
44,895
Furniture and fixtures
3 to 7
9,033
6,819
Facility construction in progress
56,574
87,987
$1,004,248
$876,587
Less accumulated depreciation and amortization
125,632
93,224
$878,616
$783,363
The Company’s construction in progress primarily consists of development costs associated with the Facility construction and design segment for contracts with various federal, state, and local agencies for which we have management contracts. Interest capitalized in property and equipment was $4.3 million and $2.9 million for the fiscal years ended December 28, 2008, and December 30, 2007, respectively.
Required
a. What is the gross interest expense for 2008 and 2007?
b. What is the interest reported on the income statement for 2008, 2007, and 2006?
c. What was the interest added to property and equipment during 2008 and 2007?
d. When is capitalized interest recognized as an expense? Describe.
e. What was the effect on income from capitalizing interest? Describe.
f. Compute times interest earned for 2008 and 2007. Comment on the absolute amounts and the trend.
Modern Building Solutions builds portable buildings to clients’ specifications. The firm has two departments: Parts Fabrication and Assembly. The Parts Fabrication Department designs and cuts the major components of the building and is highly automated. The Assembly Department assembles and installs the components and this department is highly labor intensive. The Assembly Department begins work on the buildings as soon as the floor components are available from the Parts Fabrication Department.
In its first month of operations (March 2010), Modern Building Solutions obtained contracts for three buildings:
Job 1: a 20 by 40 foot storage building
Job 2: a 35 by 35 foot commercial utility building
Job 3: a 30 by 40 foot portable classroom
Modern Building Solutions bills its customers on a cost plus basis, with profit set equal to 25 percent of costs. The firm uses a job order costing system based on normal costs. Overhead is applied in Parts Fabrication at a predetermined rate of $100 per machine hour (MH). In the Assembly Department, overhead is applied at a predetermined rate of $10 per direct labor hour (DLH). The following significant transactions occurred in March 2010:
1. Direct material was purchased on account: $80,000.
2. Direct material was issued to the Parts Fabrication Department for use in the three jobs: Job #1, $8,000; Job #2, $14,000; and Job #3, $45,000. Direct material was issued to the Assembly Department: Job #1, $500; Job #2, $1,200; and Job #3, $6,600.
3. Time sheets and payroll summaries indicated that the following direct labor costs were incurred:
Parts Fabrication Department
Assembly Department
Job #1
$1,000
$2,400
Job #2
3,000
3,500
Job #3
5,000
9,500
4. The following indirect costs were incurred in each department:
Parts Fabrication Department
Assembly Department
Labor
$ 4,200
$4,500
Utilities/Fuel
5,900
2,300
Depreciation
10,300
3,600
The labor and utilities/fuel costs were accrued at the time of the journal entry.
5. Overhead was applied based on the predetermined rates in effect in each department. The Parts Fabrication Department had 200 MHs (20 MHs on Job #1, 35 MHs on Job #2, and 145 MHs on Job #3), and the Assembly Department worked 950 DLHs (40 DLHs on Job #1, 110 DLHs on Job #2, and 800 DLHs on Job #3) for the month.
6. Job #1 was completed and sold for cash in the amount of the cost plus contract. At month end, Jobs #2 and #3 were only partially complete.
7. Any underapplied or overapplied overhead at month end is considered immaterial and is assigned to Cost of Goods Sold.
Required:
a. Record the journal entries for transactions 1–7.
b. As of the end of March 2010, determine the total cost assigned to Jobs #2 and #3.
(Job order costing documents; accounts) Following are specific types of information that can be located in a particular account (such as WIP Inventory) or on a particular document (such as an employee time card). For each item listed, identify the account or document that would provide the relevant information.
a. Total hours worked on a job by a specific employee
b. Total cost of goods manufactured during a period
c. Total cost of material issued to production for a period
d. Total product cost assigned to a particular job
e. Total manufacturing overhead cost incurred for a period
f. Total overhead cost assigned to a particular job
g. Total cost of material purchased during a period
h. Total cost of goods sold during a period
i. Total indirect labor cost incurred during a period
j. Total direct labor cost incurred during a period
(Job costing documents; ethics; writing) Salem Corp. contracted for a specialized production machine from Quindo Industries, a tool company. The contract specified a price equal to “production cost plus 15% of production cost.” A sales executive at Quindo told Salem’s management that the machine’s approximate price would be $1,725,000 based on the following estimates:
Direct material cost
$ 500,000
Direct labor cost
400,000
Manufacturing overhead (applied based on machine time)
600,000
Markup
225,000
Estimated price to Salem
$1,725,000
Two months later, Quindo Industries delivered the completed machinery, configured and manufactured as per the contract. However, the accompanying invoice caught Salem’s executives by surprise. The invoice provided the following:
Direct material cost
$ 658,000
Direct labor cost
625,000
Manufacturing overhead (applied based on machine time)
640,000
Markup
288,450
Estimated price to Salem
$2,211,450
Upon receiving the invoice, Salem executives requested an audit of the direct material charges because they were more than 30 percent higher than the original estimate. Quindo Industries granted the request and Salem hired your firm to conduct the audit.
a. Describe your strategy for validating the $658,000 charge for direct material and dis cuss specific documents you will request from Quindo Industries as part of the audit.
b. Describe your strategy for validating the $625,000 charge for direct labor and discuss specific documents you will request from Quindo Industries as part of the audit.
c. How might Quindo Industries have manipulated the predetermined overhead rate?
d. Even if all of the charges are validated, do you perceive the tool company’s behavior in this case as ethical? Explain.
(Journal entries) Nottaway Flooring produces custom made floor tiles. The company’s Raw Material Inventory account contains both direct and indirect materials. Until the end of April 2010, the company worked solely on a large job (#4263) for a major client. Near the end of the month, Nottaway began Job #4264. The following information was obtained relating to April production operations.
1. Raw material purchased on account, $204,000.
2. Direct material issued to Job #4263 cost $163,800; indirect material issued for that job cost $12,460. Direct material costing $1,870 was issued to start production of Job #4264.
3. Direct labor hours worked on Job #4263 were 3,600. Direct labor hours for Job #4264 were 120. All direct factory employees were paid $15 per hour.
4. Actual factory overhead costs incurred for the month totaled $68,700. This overhead consisted of $18,000 of supervisory salaries, $21,500 of depreciation charges, $7,200 of insurance, $12,500 of indirect labor, and $9,500 of utilities. Salaries, insurance, and utilities were paid in cash, and indirect labor charges were accrued.
5. Overhead is applied to production at the rate of $18 per direct labor hour.
Beginning balances of Raw Material Inventory and Work in Process Inventory were, respectively, $4,300 and $11,400. Of the beginning WIP balance, $800 was related to Job #4263. Job #4263 was completed during April.
a. Prepare journal entries for Transactions 1–5.
b. Determine the balance in Raw Material Inventory at the end of the month.
c. Determine the balance in Work in Process Inventory at the end of the month.
d. Determine the cost of the goods manufactured during April. If completed goods consist of 10,000 similar units, what was the cost per unit?
e. What is the amount of underapplied or overapplied overhead at the end of April?
(Cost accumulation) Croftmark Co. began operations on May 1, 2010. Its Work in Process Inventory account on May 31 appeared as follows:
Work in Process Inventory
Direct material
277,200
Cost of completed jobs
??
Direct labor
192,000
Applied overhead
268,800
The company applies overhead on the basis of direct labor cost. Only one job was still in process on May 31. That job had $75,450 in direct material and $36,200 in direct labor cost assigned to it.
a. What was the predetermined overhead application rate?
b. What was the balance in WIP Inventory at the end of May?
c. What was the total cost of jobs completed in May?
(Cost accumulation) Blaine Corp. makes floats for Mardi Gras in New Orleans. The company’s fiscal year ends on March 31. On January 1, 2010, the company’s WIP Inventory account appeared as follows:
Work in Process Inventory
Beginning balance
916,650
Cost of completed jobs
??
Direct material
589,670
Direct labor
159,600
Applied overhead
127,680
The direct labor cost contained in the beginning balance of WIP Inventory was for a total of 15,200 direct labor hours (DLHs). During January, 7,600 DLHs were recorded. Only one job was still in process on January 31. That job had $73,250 in direct material and 2,850 DLHs assigned to it.
a. If overhead is applied on the basis of DLHs, what predetermined OH rate was in effect during the company’s 2009–2010 fiscal year?
b. What was the average direct labor rate per hour?
c. What amount of direct material cost was in the beginning balance of WIP Inventory?
d. What was the balance in WIP Inventory at the end of January?
e. What was the total cost of jobs manufactured in January?
(Cost accumulation) Barfield Mfg. Co. applies overhead to jobs at a rate of 140 percent of direct labor cost. The following account information is available.
Direct Material Inventory
Work in Process Inventory
Beg. Balance
24,600
?
Beg. balance
56,000
?
Purchases
?
Direct
material
?
Direct labor
395,000
Overhead
?
4,100
27,640
Finished Goods Inventory
Cost of Goods Sold
Beg. balance
90,000
1,890,000
?
Goods
completed
?
57,000
Calculate the following items that are missing from Barfield’s account information:
(Cost accumulation) On September 25, 2010, a hurricane destroyed the work in process inventory of Biloxi Corporation. At that time, the company was in the process of manufacturing two custom jobs (B325 and Q428). Although all of Biloxi’s on site accounting records were destroyed, the following information is available from some backup off site records:
Biloxi Corp. applies overhead at the rate of 85 percent of direct labor cost.
The cost of goods sold for the company averages 75 percent of selling price. Sales from January 1 to the date of the hurricane totaled $1,598,000.
The company’s wage rate for production employees is $12.90 per hour. A total of 25,760 direct labor hours were recorded from January 1 through September 25.
As of September 25, $21,980 of direct material and 128 hours of direct labor had been recorded for Job B325. Also at that time, $14,700 of direct material and 240 hours of direct labor had been recorded for Job Q428.
January 1, 2010, inventories were as follows: $19,500 of Raw Material and $68,900 of Finished Goods. Raw materials purchased during 2010 totaled $843,276.
The amount of Work in Process Inventory at January 1, 2010, was $14,600. Jobs B325 and Q428 were not in process on January 1.
One job, R91, was completed and in the warehouse awaiting shipment on September 25. The total cost of this job was $165,600.
Determine the following amounts:
a. Cost of goods sold for the year
b. Cost of goods manufactured during the year
c. Amount of applied overhead for each job in WIP Inventory
d. Cost of WIP Inventory destroyed by the hurricane
e. Cost of RM Inventory destroyed by the hurricane
(Cost accumulation; assigning costs to jobs) The law firm of Taub & Lawson,LLP, currently has four cases in process. Following is information related to those cases as of the end of March 2010:
Case #1
Case #2
Case #3
Case #4
Direct material
$480
$8,800
$3,700
$850
Direct labor hours ($190 per hour)
40
90
70
15
Estimated court hours
12
65
120
40
Taub & Lawson allocates overhead to cases based on a predetermined rate of $150 per estimated court hour.
a. Determine the total cost assigned to each case as of March 31, 2010.
b. Case #3 was completed at the end of April 2010. At that time, $10,100 of direct materials had been used and 174 direct labor hours had been incurred. Of the
DLHs, 72 had been spent in court. Taub & Lawson’s policy is to charge client costs plus 45 percent. What amount will be billed to the client involved in Case #3?
(Cost accumulation in two departments) Rio Valde Co. uses a normal cost, job order costing system. In the Mixing Department, overhead is applied using machine hours; in Paving, overhead is applied using direct labor hours. In December 2009, the company estimated the following data for its two departments for 2010:
Mixing Department
Paving Department
Direct labor hours
12,000
28,000
Machine hours
60,000
12,000
Budgeted overhead cost
$480,000
$700,000
a. Compute the predetermined OH rate for each department of Rio Valde.
b. Job #220 was started and completed during March 2010. The job cost sheet shows the following information:
Mixing Department
Paving Department
Direct material
$22,600
$3,400
Direct labor cost
$1,250
$4,050
Direct labor hours
24
340
Machine hours
290
44
Compute the overhead applied to Job #220 for each department and in total.
c. The president of Rio Valde suggested that, for simplicity, a single predetermined overhead rate be computed using machine hours. How much overhead would have been applied to Job #220 if that single rate had been used? Would such a rate have indicated the actual overhead cost of each job? Explain.
The following data apply to items (a) and (b). Mr. Sparks, the owner of School Supplies, Inc., wants to maintain control over accounts receivable. He understands that accounts receivable turnover will give a good indication of how well receivables are being managed. School Supplies, Inc., does 70% of its business during June, July, and August. The terms of sale are 2/10, net/60.
Net sales for the year ended December 31, 2009, and receivables balances follow:
Net sales $1,500,000 Receivables, less allowance for doubtful accounts of $8,000 at January 1, 2009 72,000 Receivables, less allowance for doubtful accounts of $10,000 at December 31, 2009 60,000 Required Answer the following multiple choice questions:
a. The average accounts receivable turnover calculated from the previous data is
1. 20.0 times.
2. 25.0 times.
3. 22.7 times.
4. 18.75 times.
5. 20.8 times.
b. The average accounts receivable turnover computed for School Supplies, Inc., in item (a) is
Required Answer the following multiple choice questions:
a. A company’s current ratio is 2.2 to 1 and quick (acid test) ratio is 1.0 to 1 at the beginning of the year. At the end of the year, the company has a current ratio of 2.5 to 1 and a quick ratio of 0.8 to 1.
Which of the following could help explain the divergence in the ratios from the beginning to the end of the year?
1. An increase in inventory levels during the current year
2. An increase in credit sales in relationship to cash sales
3. An increase in the use of trade payables during the current year
4. An increase in the collection rate of accounts receivable
5. The sale of marketable securities at a price below cost
b. If, just prior to a period of rising prices, a company changed its inventory measurement method from FIFO to LIFO, the effect in the next period would be to
1. Increase both the current ratio and inventory turnover.
2. Decrease both the current ratio and inventory turnover.
3. Increase the current ratio and decrease inventory turnover.
4. Decrease the current ratio and increase inventory turnover.
5. Leave the current ratio and inventory turnover unchanged.
c. Selected year end data for Bayer Company are as follows:
Current liabilities
$600,000
Acid test ratio
2.5
Current ratio
3.0
Cost of sales
$500,000
Bayer Company’s inventory turnover based on these year end data is
1. 1.20.
2. 2.40.
3. 1.67.
4. Some amount other than those given.
5. Not determinable from the data given.
d. If a firm has a high current ratio but a low acid test ratio, one can conclude that
1. The firm has a large outstanding accounts receivable balance.
2. The firm has a large investment in inventory.
3. The firm has a large amount of current liabilities.
4. The cash ratio is extremely high.
5. The two ratios must be recalculated because both conditions cannot occur simultaneously.
e. Investment instruments used to invest temporarily idle cash balances should have which of the following characteristics?
1. High expected return, low marketability, and a short term to maturity
2. High expected return, readily marketable, and no maturity date
3. Low default risk, low marketability, and a short term to maturity
4. Low default risk, readily marketable, and a long term to maturity
5. Low default risk, readily marketable, and a short term to maturity
f. The primary objective in the management of accounts receivable is
1. To achieve a combination of sales volume, bad debt experience, and receivables turnover that maximizes the profits of the corporation.
2. To realize no bad debts because of the opportunity cost involved.
3. To provide the treasurer of the corporation with sufficient cash to pay the company’s bills on time.
4. To coordinate the activities of manufacturing, marketing, and financing so that the corporation can maximize its profits.
5. To allow the most liberal credit acceptance policy because increased sales mean increased profits.
g. A firm requires short term funds to cover payroll expenses. These funds can come from
Consecutive five year balance sheets and income statements of Anne Gibson Corporation follow:
ANNE GIBSON CORPORATION Balance Sheet December 31, 2005 through December 31, 2009
(Dollars in thousands)
2009
2008
2007
2006
2005
Assets:
Current assets
Cash
$47,200
$46,000
$45,000
$44,000
$43,000
Marketable securities
2,000
2,500
3,000
3,000
3,000
Accounts receivable,
less allowance of
$1,000, December 31, 2009;
$900, December 31, 2008;
$900, December 31, 2007;
$800, December 31, 2006;
$1,200, December 31, 2005
131,000
128,000
127,000
126,000
125,000
Inventories
122,000
124,000
126,000
127,000
125,000
Prepaid expenses
3,000
2,500
2,000
1,000
1,000
Total current assets
305,200
303,000
303,000
301,000
297,000
Property, plant and equipment, net
240,000
239,000
238,000
237,500
234,000
Other assets
10,000
8,000
7,000
6,500
7,000
Total assets
$555,200
$550,000
$548,000
$545,000
$538,000
Liabilities and stockholders’ equity:
Current liabilities
Accounts payable
$72,000
$73,000
$75,000
$76,000
$78,500
Accrued compensation
26,000
25,000
25,500
26,000
26,000
Income taxes
11,500
12,000
13,000
12,500
11,000
Total current liabilities
109,500
110,000
113,500
114,500
115,500
Long term debt
68,000
60,000
58,000
60,000
62,000
Deferred income taxes
25,000
24,000
23,000
22,000
21,000
Stockholders’ equity
352,700
356,000
353,500
348,500
339,500
Total liabilities and stockholders’ equity
$555,200
$550,000
$548,000
$545,000
$538,000
ANNE GIBSON CORPORATION Statement of Earnings For Years Ended December 31, 2005–2009
(In thousands, except per share)
2009
2008
2007
2006
2005
Net sales
$880,000
$910,000
$840,000
$825,000
$820,000
Cost of goods sold
740,000
760,000
704,000
695,000
692,000
Gross profit
140,000
150,000
136,000
130,000
128,000
Selling and administrative expense
53,000
52,000
50,000
49,800
49,000
Interest expense
6,700
5,900
5,800
5,900
6,000
Earnings from continuing operations before income taxes
80,300
92,100
80,200
74,300
73,000
Income taxes
26,000
27,500
28,000
23,000
22,500
Net earnings
$54,300
$64,600
$52,200
$51,300
$50,500
Earnings per share
$1.40
$1.65
$1.38
$1.36
$1.33
Required
a. Using year end balance sheet figures, compute the following for the maximum number of years, based on the available data:
1. Days’ sales in receivables
2. Accounts receivable turnover
3. Accounts receivable turnover in days
4. Days’ sales in inventory
5. Inventory turnover
6. Inventory turnover in days
7. Operating cycle
8. Working capital
9. Current ratio
10. Acid test ratio
11. Cash ratio
12. Sales to working capital
b. Using average balance sheet figures, as suggested in the chapter, compute the following for the maximum number of years, based on the available data:
1. Days’ sales in receivables
2. Accounts receivable turnover
3. Accounts receivable turnover in days
4. Days’ sales in inventory
5. Inventory turnover
6. Inventory turnover in days
7. Operating cycle
8. Working capital
9. Current ratio
10. Acid test ratio
11. Cash ratio
12. Sales to working capital
c. Comment on trends indicated in short term liquidity.
Allowance for Uncollectible Accounts—Ethics vs. Conservatism To aid in determining the balance for the allowance for uncollectible accounts, an aging schedule is often prepared. The Arrow Company prepared the following aging schedule for December 31, 2009:
ARROW COMPANY Aging Schedule of Accounts Receivable
Age of Accounts
Receivable Balance
Estimate Percent Uncollectible
Estimated Uncollectible Accounts
Current
$120,000
1.50%
$1,800
1–30 days past due
40,000
2
800
31–60 days past due
30,000
3
900
61–90 days past due
20,000
4
800
Over 90 days past due
25,000
7
1,750
Total
$235,000
$6,050
The current balance in allowance for uncollectible accounts is $2,000. The president of Arrow Company directs that the allowance be adjusted to $12,000. His reasoning is that 2009 has been a bad year for profits. Additional expenses this year will hardly be noticed, and this will help profits in future years.
Required
a. 1. If the allowance for uncollectible accounts is adjusted to $6,050, how much will this add to expense for 2009?
2. If the allowance for uncollectible accounts is adjusted to $12,000, how much will this add to expense for 2009?
b. Is the president’s direction an example of conservatism or unethical? Comment.
AK STEEL HOLDING CORPORATION* CONSOLIDATED BALANCE SHEETS December 31, 2008 and 2007 (Dollars in millions, except per share amounts)
2008
2007
ASSETS
Current Assets:
Cash and cash equivalents
$562.70
$713.60
Accounts receivable, net
469.9
675
Inventories, net
566.8
646.8
Deferred tax asset
333
357.6
Other current assets
70.4
33.8
Total Current Assets
2,002.80
2,426.80
Property, Plant, and Equipment
5,282.10
5,131.10
Less accumulated depreciation
3,220.80
3,065.20
Property, plant, and equipment, net
2,061.30
2,065.90
Other Assets:
Investment in AFSG
55.6
55.6
Other investments
50.4
42.9
Goodwill
37.1
37.1
Other intangible assets
0.3
0.3
Deferred tax asset
459.1
549.5
Other
15.4
19.3
TOTAL ASSETS
$4,682.00
$5,197.40
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts payable
$348.10
$588.20
Accrued liabilities
233
214
Current portion of pension and other postretirement
benefit obligations
152.4
158
Total Current Liabilities
734.2
972.9
Noncurrent Liabilities:
Long term debt
632.6
652.7
Pension and other postretirement benefit obligations
2,144.20
2,537.20
Other liabilities
203
159.9
Total Noncurrent Liabilities
2,979.80
3,349.80
TOTAL LIABILITIES
3,714.00
4,322.70
Stockholders’ Equity:
Preferred stock, authorized 25,000,000 shares
Common stock, authorized 200,000,000 shares of $.01 par value each; issued 2008, 121,105,429 shares, 2007, 20,302,930 shares; outstanding 2008, 110,394,774 shares; 2007, 111,497,682 shares
1.2
1.2
Additional paid in capital
1,898.90
1,867.60
Treasury stock, common shares at cost, 2008, 10,710,655; 2007, 8,805,248 shares
150.8
126.8
Accumulated deficit
940.9
915.1
Accumulated other comprehensive loss
159.6
47.8
TOTAL STOCKHOLDERS’ EQUITY
968
874.7
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$4,682.00
$5,197.40
Required
a. What is the working capital at the end of 2008?
b. What is the balance in the LIFO reserve account at the end of 2008? Describe this account.
c. If the LIFO reserve account was added to the inventory at LIFO, what would be the resulting inventory number at the end of 2008? Which inventory amount do you consider to be more realistic?
d. Does the use of LIFO or FIFO produce higher, lower, or the same income during (1) price increases; (2) price decreases; and (3) constant prices? (Assume no decrease or increase in inventory quantity.)
e. Does the use of LIFO or FIFO produce higher, lower, or the same amount of cash flow during (1) price increases; (2) price decreases; and (3) constant costs? Answer the question for both pretax cash flows and after tax cash flows. (Assume no decrease or increase in inventory quantity.)
f. Assume that the company purchased inventory on the last day of the year, beginning inventory equaled ending inventory, and inventory records for the item purchases were maintained periodically on the LIFO basis. Would that purchase be included on the income statement or the balance sheet at year end?
g. Explain how liquidation of LIFO layers generates income.
The following information was taken directly from the annual report of a firm that wishes to remain anonymous. (The dates have been changed.)
FINANCIAL SUMMARY
Effects of LIFO Accounting
For a number of years, the corporation has used the last in, first out (LIFO) method of accounting for its steel inventories. In periods of extended inflation, coupled with uncertain supplies of raw materials from foreign sources, and rapid increases and fluctuations in prices of raw materials such as nickel and chrome nickel scrap, earnings can be affected unrealistically for any given year.
Because of these factors, the corporation will apply to the Internal Revenue Service for permission to discontinue using the LIFO method of accounting for valuing those inventories for which this method has been used. If such application is granted, the LIFO reserve at December 31, 2009, of $12,300,000 would be eliminated, which would require a provision for income taxes of approximately $6,150,000. The corporation will also seek permission to pay the increased taxes over a 10 year period. If the corporation had not used the LIFO method of accounting during 2008, net earnings for the year would have been increased by approximately $1,500,000.
The 2009 annual report also disclosed the following:
2009
2008
1. Sales and revenues
$536,467,782
$487,886,449
2. Earnings per common share
$3.44
$3.58
Required
a. The corporation indicates that earnings can be affected unrealistically by rapid increases and fluctuations in prices when using LIFO. Comment.
b. How much taxes will need to be paid on past earnings from the switch from LIFO? How will the switch from LIFO influence taxes in the future?
c. How will a switch from LIFO affect 2009 profits?
d. How will a switch from LIFO affect future profits?
e. How will a switch from LIFO affect 2009 cash flow?
f. How will a switch from LIFO affect future cash flow?
g. Speculate on the real reason that the corporation wishes to switch from LIFO.
EASTMAN KODAK COMPANY* CONSOLIDATED STATEMENT OF OPERATIONS
For the Year Ended December 31,
(In millions, except per share data)
2008
2007
2006
Net sales
$9,416
$10,301
$10,568
Cost of goods sold
7,247
7,757
8,122
Gross profit
2,169
2,544
2,446
Selling, general, and administrative expenses
1,583
1,778
1,969
Research and development costs
501
549
596
Restructuring costs, rationalization, and other
140
543
416
Loss from continuing operations before interest expense, other income (charges), net and income taxes
821
230
476
Interest expense
108
113
172
Other income (charges), net
55
87
65
Loss from continuing operations before income taxes
874
256
583
(Benefit) provision for income taxes
147
51
221
Loss from continuing operations
($727)
($205)
($804)
Earnings from discontinued operations, net of income taxes
$285
$881
$203
NET (LOSS) EARNINGS
($442)
$676
($601)
Basic and diluted net (loss) earnings per share:
Continuing operations
($2.58)
($0.71)
($2.80)
Discontinued operations
1.01
3.06
0.71
Total
($1.57)
$2.35
($2.09)
Cash dividends per share
$0.50
$0.50
$0.50
EASTMAN KODAK COMPANY CONSOLIDATED STATEMENT OF FINANCIAL POSITION
At December 31,
(In millions, except share and per share data)
2008
2007
ASSETS
Current assets
Cash and cash equivalents
$2,145
$2,947
Receivables, net
1,716
1,939
Inventories, net
948
943
Other current assets
195
224
Total current assets
5,004
6,053
Property, plant, and equipment, net
1,551
1,811
Goodwill
896
1,657
Other long-term assets
1,728
4,138
Total assets
$9,179
$13,659
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities
Accounts payable and other current liabilities
$3,267
$3,794
Short-term borrowings and current portion of long-term debt
51
308
Accrued income and other taxes
144
344
Total current liabilities
3,462
4,446
Long-term debt, net of current portion
1,252
1,289
Pension and other postretirement liabilities
2,382
3,444
Other long-term liabilities
1,122
1,451
Total liabilities
8,218
10,630
Commitments and Contingencies (Note 10)
SHAREHOLDERS’ EQUITY
Common stock, $2.50 par value, 950,000,000 shares authorized; 391,292,760 shares issued as of December 31, 2008 and 2007; 268,169,055 and 287,999,830 shares outstanding as of December 31, 2008 and 2007
978
978
Additional paid in capital
901
889
Retained earnings
5,879
6,474
Accumulated other comprehensive (loss) income
749
452
7,009
8,793
Treasury stock, at cost; 123,123,705 shares as of December 31, 2008 and 103,292,930 shares as of December 31, 2007
6,048
5,764
Total shareholders’ equity
961
3,029
Total liabilities and shareholders’ equity
$9,179
$13,659
EASTMAN KODAK COMPANY Notes to Financial Statements (In Part)
NOTE 2: RECEIVABLES, NET
As of December 31,
(In millions)
2008
2007
Trade receivables
$1,330
$1,697
Miscellaneous receivables
386
242
Total (net of allowances of $113 and $114 as of December 31, 2008 and 2007, respectively)
$1,716
$1,939
Of the total trade receivables amounts of $1,330 million and $1,697 million as of December 31, 2008 and 2007, respectively, approximately $218 million and $266 million, respectively, are expected to be settled through customer deductions in lieu of cash payments. Such deductions represent rebates owed to the customer and are included in accounts payable and other current liabilities in the accompanying Consolidated Statement of Financial Position at each respective balance sheet date.
The increase in miscellaneous receivables is primarily due to an amendment to an intellectual property licensing agreement with an existing licensee executed during the third quarter of 2008. Under the terms of this amendment, cash consideration is to be received in 2009. ‘‘Other Long-Term Liabilities.’’
Required
a. Based on these data, calculate the following for 2008 and 2007:
1. Days’ sales in receivables (use trade receivables)
2. Accounts receivable turnover (use gross trade receivables at year-end)
3. Days’ sales in inventory
4. Inventory turnover (use year-end inventory)
5. Working capital
6. Current ratio
7. Acid-test ratio
b. Comment on each ratio individually.
c. Why are portions of long-term debt included in short-term borrowings?
d. Prepare a vertical common-size analysis for the balance sheets using 2008 and 2007 (use total assets as the base).
The Grand retail firm reported the following financial data for the past several years:
Year
(Amounts in thousands)
5
4
3
2
1
Sales
$1,254,131
$1,210,918
$1,096,152
$979,458
$920,797
Net accounts receivable
419,731
368,267
312,776
72,450
230,427
The Grand retail firm had a decentralized credit operation allowing each store to administer its credit operation. Many stores provided installment plans allowing the customer up to 36 months to pay. Gross profits on installment sales were reflected in the financial statements in the period when the sales were made.
Required
a. Using Year 1 as the base, prepare horizontal common size analysis for sales and net accounts receivable.
b. Compute the accounts receivable turnover for Years 2–5. (Use net accounts receivable.)
c. Would financial control of accounts receivable be more important with installment sales than with sales on 30 day credit? Comment.
d. Comment on what is apparently happening at The Grand retail firm.
AMERICAN GREETINGS* CONSOLIDATED STATEMENTS OF OPERATIONS Years ended February 28, 2009, February 29, 2008, and February 28, 2007 (Thousands of dollars except share and per share amounts)
2009
2008
2007
Net sales
$1,646,399
$1,730,784
$1,744,798
Other revenue
44,339
45,667
49,492
Total revenue
1,690,738
1,776,451
1,794,290
Material, labor, and other production costs
809,956
780,771
826,791
Selling, distribution, and marketing expenses
618,899
621,478
627,940
Administrative and general expenses
226,317
246,722
253,035
Goodwill and other intangible assets impairment
290,166
—
2,196
Other operating income —net
1,396
1,325
5,252
Operating (loss) income
253,204
128,805
89,580
Interest expense
22,854
20,006
34,986
Interest income
3,282
7,758
8,135
Other nonoperating expense (income) —net
2,157
7,411
2,682
(Loss) income from continuing operations before income tax (benefit) expense
274,933
123,968
65,411
Income tax (benefit) expense
47,174
40,648
25,473
(Loss) income from continuing operations
227,759
83,320
39,938
(Loss) income from discontinued operations, net of tax
—
317
2,440
Net (loss) income
($227,759)
$83,003
$42,378
(Loss) earnings per share— basic:
(Loss) income from continuing operations
($4.89)
1.54
0.69
(Loss) income from discontinued operations
—
0.01
0.04
Net (loss) income
($4.89)
1.53
0.73
(Loss) earnings per share— assuming dilution:
(Loss) income from continuing operations
($4.89)
$1.53
$0.67
(Loss) income from discontinued operations
—
0.01
0.04
Net (loss) income
($4.89)
$1.52
$0.71
Average number of shares outstanding
46,543,780
54,236,961
57,951,952
Average number of shares outstanding — assuming dilution
46,543,780
54,506,048
62,362,794
Dividends declared per share
$0.60
$0.40
$0.32
CONSOLIDATED STATEMENT OF FINANCIAL POSITION February 28, 2009 and February 29, 2008 (Thousands of dollars except share and per share amounts)
2009
2008
ASSETS
CURRENT ASSETS
Cash and cash equivalents
$60,216
$123,500
Trade accounts receivable, net
63,281
61,902
Inventories
203,873
216,671
Deferred and refundable income taxes
71,850
72,280
Prepaid expenses and other
162,175
195,017
Total current assets
561,395
669,370
GOODWILL
26,871
285,072
OTHER ASSETS
368,958
420,219
DEFERRED AND REFUNDABLE
INCOME TAXES
178,785
133,762
PROPERTY, PLANT AND
EQUIPMENT NET
297,779
296,005
$1,433,788
$1,804,428
LIABILITIES AND SHARHOLDERS’ EQUITY
CURRENT LIABILITIES
Debt due within one year
$750
$22,690
Accounts payable
117,504
123,713
Accrued liabilities
75,673
79,345
Accrued compensation and benefits
32,198
68,669
Income taxes payable
11,743
29,037
Other current liabilities
105,537
108,867
Total current liabilities
343,405
432,321
LONG-TERM DEBT
389,473
220,618
OTHER LIABILITIES
149,820
171,720
DEFERRED INCOME TAXES AND NONCURRENT INCOME TAXES PAYABLE
21,910
26,358
SHAREHOLDERS’ EQUITY
Common shares—par value $1 per share:
Class A— 80,548,353 shares issued less 43,505,203 treasury shares in 2009 and 80,522,153 shares issued less 35,198,300 treasury shares in 2008
37,043
45,324
Class B—6,066,092 shares issued less 2,566,875 treasury shares in 2009 and 6,066,092 shares issues less 2,632,087 treasury shares in 2008
3,499
3,434
Capital in excess of par value
449,085
445,696
Treasury stock
938,086
872,949
Accumulated other comprehensive (loss) income
67,278
21,244
Retained earnings
1,044,926
1,300,662
Total shareholders’ equity
529,189
943,411
$1,433,788
$1,804,428
Required
a. Based on these data, calculate the following for 2009 and 2008:
1. Days’ sales in receivables
2. Accounts receivable turnover (gross receivables at year-end)
3. Days’ sales in inventory
4. Inventory turnover (use inventory at year-end)
5. Working capital
6. Current ratio
7. Acid-test ratio
b. Comment on each ratio individually
c. 1. Describe the individual allowance consideration
2. Are some of these allowance considerations normal for most companies?
d. What would be the inventory balance at February 28, 2009, if the LIFO reserve were removed?
e. Were there material LIFO liquidations in 2009, 2008, or 2007?
With this case, we review the liquidity of several specialty retail stores. The companies reviewed and the year end dates are as follows:
1. Abercrombie & Fitch Co. (January 31, 2009—52 week; February 2, 2008—52 week; February 3, 2007—53 week) ‘‘Abercrombie & Fitch Co …is a specialty retailer that operates stores and websites selling casual sportswear apparel.’’ 10 K
2. Limited Brands, Inc. (January 31, 2009—52 week; February 2, 2008—52 week; February 3, 2007—53 week) ‘‘We operate in the highly competitive specialty retail business.’’ 10 K
3. Gap Inc. (January 31, 2009—52 week; February 2, 2008—52 week; February 3, 2007—53 week) ‘‘We are a global specialty retailer offering clothing, accessories, and personal care products.’’ 10 K
Abercrombie Fitch
Limited Brands
GAP
Data Reviewed
2009
2008
2009
2008
2009
2008
Current ratio
2.41
2.10
2.28
2.12
1.86
1.68
Acid test
1.28
1.29
1.12
1.00
.79
.78
Required
a. For each company, indicate the trend in liquidity.
b. How would you rank these companies, considering liquidity?
With this case, we review the liquidity of several restaurant companies. The restaurant companies reviewed and the year end dates are as follows:
1. Yum Brands, Inc. (December 27, 2008; December 29, 2007) ‘‘Through the five concepts of KFC, Pizza Hut, Taco Bell, LJS and Arco (the ‘‘Concepts’’), the company develops, operates, franchises and licenses a world system of restaurants which prepare, package and sell a menu of competitively priced food items.’’ 10 K
2. Panera Bread (December 30, 2008; December 25, 2007) ‘‘As of December 30, 2008, Panera operated directly and through franchise agreements with 39 franchise groups and 1,252 cafes.’’ 10 K
3. Starbucks (September 28, 2008; September 30, 2007) ‘‘Starbucks Corporation was formed in 1985 and today is the world’s leading roaster and retailer of specialty coffee.’’ 10 K
Yum Brands, Inc.
Panera Bread
Starbucks
Data Reviewed
2008
2007
2008
2007
2008
2007
Current ratio
0.55
0.72
1.21
1.19
0.8
0.79
Acid test
0.26
0.49
0.81
0.91
0.3
0.34
Required
a. For each company, indicate the trend in liquidity.
b. Give your opinion as to the relative liquidity of each of these companies. How would you rank these companies, considering liquidity?
Capital leases that have not been capitalized will decrease the times interest earned ratio. Comment.
Indicate the status of pension liabilities under the Employee Retirement Income Security Act.
Why is the vesting provision an important provision of a pension plan? How has the Employee Retirement Income Security Act influenced vesting periods?
Indicate the risk to a company if it withdraws from a multiemployer pension plan or if the multiemployer pension plan is terminated.
Operating leases are not reflected on the balance sheet, but they are reflected on the income statement in the rent expense. Comment on why an interest expense figure that relates to long term operating leases should be considered when determining a fixed charge coverage.
What portion of net worth can the federal government require a company to use to pay for pension obligations?
Consider the debt ratio. Explain a position for including short term liabilities in the debt ratio. Explain a position for excluding short term liabilities from the debt ratio. Which of these approaches would be more conservative?
Consider the accounts of bonds payable and reserve for rebuilding furnaces. Explain how one of these accounts could be considered a firm liability and the other could be considered a soft liability.
Explain why deferred taxes that are disclosed as long term liabilities may not result in actual cash outlays in the future.
A firm has a high current debt/net worth ratio in relation to prior years, competitors, and the industry. Comment on what this tentatively indicates.
Comment on the implications of relying on a greater proportion of short term debt in relation to long term debt.
When a firm guarantees a bank loan for a joint venture in which it participates and the joint venture is handled as an investment, then the overall potential debt position will not be obvious from the face of the balance sheet. comment.
When examining financial statements, a note that describes contingencies should be reviewed closely for possible significant liabilities that are not disclosed on the face of the balance sheet. Comment.
There is a chance that a company may be in a position to have large sums transferred from the pension fund to the company. Comment.
Indicate why comparing firms for postretirement benefits other than pensions can be difficult.
Presents the marketable securities on the 2009 annual report of Nike, Inc. It discloses the detail of the marketable securities account. Many companies do not disclose this detail.
Indicates the disclosure by CA, Inc., and Subsidiaries. Customer concentration can be an important consideration in the quality of receivables. When a large portion of receivables is from a few customers, the firm can be highly dependent on those customers.
Nike’s Form 10 K disclosed that ‘‘no customer accounted for 10% or more of our net sales during fiscal 2009.’’
CA, INC., AND SUBSIDIARIES*
Installment Receivables
CA, Inc., and Subsidiaries Consolidated Balance Sheets (In Part)
March 31,
(Dollars in Millions)
2009
2008
ASSETS
Current Assets
Cash, cash equivalents, and marketable securities
$2,713
$2,796
Trade and installment accounts receivable, net
839
970
Deferred income taxes —current
524
623
Other current assets
104
79
Total Current Assets
4,180
4,468
Installment accounts receivable, due after one year, net
128
234
Property and equipment
Land and buildings
199
256
Equipment, furniture, and improvements
1,258
1,236
1,457
1,492
Accumulated depreciation and amortization
1,015
996
Total Property and Equipment, net
442
496
Purchased software products, net accumulated amortization of $4,715 and $4,662, respectively
Presents this computation for Nike at the end of 2009 and 2008. The turnover of receivables decreased between 2008 and 2009 from 6.94 times per year to 6.62 times per year. For
Would a company that uses a natural business year tend to overstate or understate the liquidity of its receivables? Explain.
T. Melcher Company uses the calendar year. Sales are at a peak during the holiday season, and T. Melcher Company extends 30 day credit terms to customers. Comment on the expected liquidity of its receivables, based on the days’ sales in receivables and the accounts receivable turnover.
A company that uses a natural business year, or ends its year when business is at a peak, will tend to distort the liquidity of its receivables when end of year and beginning of year receivables are used in the computation. Explain how a company that uses a natural business year or ends its year when business is at a peak can eliminate the distortion in its liquidity computations.
Hawk Company wants to determine the liquidity of its receivables. It has supplied you with the following data regarding selected accounts for December 31, 2009, and 2008:
2009
2008
Net sales
$1,180,178
$2,200,000
Receivables, less allowance for losses and discounts
Beginning of year (allowance for losses and
discounts, 2009—$12,300; 2008—$7,180)
240,360
230,180
End of year (allowance for losses and discounts,
2009—$11,180; 2008—$12,300)
220,385
240,360
Required
a. Compute the number of days’ sales in receivables at December 31, 2009, and 2008.
b. Compute the accounts receivable turnover for 2009 and 2008. (Use year end gross receivables.
c. Comment on the liquidity of Hawk Company receivables.
Mr. Williams, the owner of Williams Produce, wants to maintain control over accounts receivable. He understands that days’ sales in receivables and accounts receivable turnover will give a good indication of how well receivables are being managed. Williams Produce does 60% of its business during June, July, and August. Mr. Williams provided the following pertinent data:
For Year Ended
December 31, 2009
For Year Ended
July 31, 2008
Net sales
$800,000
$790,000
Receivables, less allowance for doubtful accounts
Beginning of period (allowance January 1,
$3,000; August 1, $4,000)
50,000
89,000
End of period (allowance December 31,
$3,500; July 31, $4,100)
55,400
90,150
Required
a. Compute the days’ sales in receivables for July 31, 2009, and December 31, 2009, based on the accompanying data.
b. Compute the accounts receivable turnover for the period ended July 31, 2009, and December 31, 2009. (Use year end gross receivables.)
Solomon Company would like to compare its days’ sales in receivables with that of a competitor, L. Konrath Company. Both companies have had similar sales results in the past, but L. Konrath Company has had better profit results. L. Solomon Company suspects that one reason for the better profit results is that L. Konrath Company did a better job of managing receivables. L. Solomon Company uses a calendar year that ends on December 31, while L. Konrath Company uses a fiscal year that ends on July 31. Information related to sales and receivables of the two companies follows:
For Year Ended December 31, 20XX
L. Solomon Company
Net sales
$1,800,000
Receivables, less allowance for doubtful accounts of $8,000
110,000
For Year Ended July 31, 20XX
L. Konrath Company
Net sales
$1,850,000
Receivables, less allowance for doubtful accounts of $4,000
60,000
Required
a. Compute the days’ sales in receivables for both companies. (Use year end gross receivables.)
Anna Banana Company would like to estimate how long it will take to realize cash from its ending inventory. For this purpose, the following data are submitted:
Accounts receivable, less allowance for doubtful accounts of $30,000
560,000
Ending inventory
680,000
Net sales
4,350,000
Cost of goods sold
3,600,000
Required
Estimate how long it will take to realize cash from the ending inventory.
Laura Badora Company has been using LIFO inventory. The company is required to disclose the replacement cost of its inventory and the replacement cost of its cost of goods sold on its annual statements. Selected data for the year ended 2009 are as follows:
Ending accounts receivable, less allowance for doubtful accounts of $25,000
Individual transactions often have a significant impact on ratios. This problem will consider the direction of such an impact.
Total Current Assets
Total Current Liabilities
Net Working Capital
Current Ratio
a. Cash is acquired through issuance of additional common stock.
______
______
______
______
b. Merchandise is sold for cash. (Assume a profit.)
_________
_________
_________
_________
c. A fixed asset is sold for more than book value.
_________
_________
_________
_________
d. Payment is made to trade creditors for previous purchases.
_________
_________
_________
_________
e. A cash dividend is declared and paid.
_________
_________
_________
_________
f. A stock dividend is declared and paid.
_________
_________
_________
_________
g. Cash is obtained through long term bank loans.
_________
_________
_________
_________
h. A profitable firm increases its fixed assets depreciation allowance account.
_________
_________
_________
_________
i. Current operating expenses are paid.
_________
_________
_________
_________
j. Ten year notes are issued to pay off accounts payable.
_________
_________
_________
_________
k. Accounts receivable are collected.
_________
_________
_________
_________
l. Equipment is purchased with short term notes.
_________
_________
_________
_________
m. Merchandise is purchased on credit.
_________
_________
_________
_________
n. The estimated taxes payable are increased.
_________
_________
_________
_________
o. Marketable securities are sold below cost.
_________
_________
_________
_________
Required
Indicate the effects of the previous transactions on each of the following: total current assets, total current liabilities, net working capital, and current ratio. Use + to indicate an increase, to indicate a decrease, and 0 to indicate no effect. Assume an initial current ratio of more than 1 to 1.
Anne Elizabeth Corporation is engaged in the business of making toys. A high percentage of its products are sold to consumers during November and December. Therefore, retailers need to have the toys in stock prior to November. The corporation produces on a relatively stable basis during the year in order to retain its skilled employees and to minimize its investment in plant and equipment.
The seasonal nature of its business requires a substantial capacity to store inventory. The gross receivables balance at April 30, 2008, was $75,000, and the inventory balance was $350,000 on this date. Sales for the year ended April 30, 2009, totaled $4,000,000, and the cost of goods sold totaled $1,800,000.
Anne Elizabeth Corporation uses a natural business year that ends on April 30. Inventory and accounts receivable data are given in the following table for the year ended April 30, 2009:
Month End Balance
Month
Gross Receivables
Inventory
May 2008
60,000
$525,000
June 2008
40,000
650,000
July 2008
50,000
775,000
August 2008
60,000
900,000
September 2008
200,000
975,000
October 2008
800,000
700,000
November 2008
1,500,000
400,000
December 2008
1,800,000
25,000
January 2009
1,000,000
100,000
February 2009
600,000
150,000
March 2009
200,000
275,000
April 2009
50,000
400,000
Required
a. Using averages based on the year end figures, compute the following:
1. Accounts receivable turnover in days
2. Accounts receivable turnover per year
3. Inventory turnover in days
4. Inventory turnover per year
b. Using averages based on monthly figures, compute the following:
1. Accounts receivable turnover in days
2. Accounts receivable turnover per year
3. Inventory turnover in days
4. Inventory turnover per year
c. Comment on the difference between the ratios computed in (a) and (b).
d. Compute the days’ sales in receivables.
e. Compute the days’ sales in inventory.
f. How realistic are the days’ sales in receivables and the days’ sales in inventory that were computed in (d) and (e)?
The following data relate to inventory for the year ended December 31, 2009. A physical inventory on December 31, 2009, indicates that 600 units are on hand and that they came from the July 1 purchase.
Date
Description
Number of Units
Cost per Unit
Total Cost
January
Beginning inventory
1,000
$4.00
4,000
February 20
Purchase
800
4.50
3,600
April
Purchase
900
4.75
4,275
July
Purchase
700
5.00
3,500
October 22
Purchase
500
4.90
2,450
December 10
Purchase
500
5.00
2,500
4,400
$20,325
Required Compute the cost of goods sold for the year ended December 31, 2009, and the ending inventory under the following cost assumptions:
Depoole Company manufactures industrial products and employs a calendar year for financial reporting purposes. Items (a) through (e) present several of Depoole’s transactions during 2009.
The total of cash equivalents, marketable securities, and net receivables exceeded total current liabilities both before and after each transaction described. Depoole had positive profits in 2009 and a credit balance throughout 2009 in its retained earnings account.
Required Answer the following multiple choice questions:
a. Payment of a trade account payable of $64,500 would
1. Increase the current ratio, but the acid test ratio would not be affected.
2. Increase the acid test ratio, but the current ratio would not be affected.
3. Increase both the current and acid test ratios.
4. Decrease both the current and acid test ratios.
5. Have no effect on the current and acid test ratios.
b. The purchase of raw materials for $85,000 on open account would
1. Increase the current ratio.
2. Decrease the current ratio.
3. Increase net working capital.
4. Decrease net working capital.
5. Increase both the current ratio and net working capital.
c. The collection of a current accounts receivable of $29,000 would
1. Increase the current ratio.
2. Decrease the current ratio.
3. Increase the acid test ratio.
4. Decrease the acid test ratio.
5. Not affect the current or acid test ratios.
d. Obsolete inventory of $125,000 was written off during 2009. This would
1. Decrease the acid test ratio.
2. Increase the acid test ratio.
3. Increase net working capital.
4. Decrease the current ratio.
5. Decrease both the current and acid test ratios.
e. The early liquidation of a long term note with cash would
1. Affect the current ratio to a greater degree than the acid test ratio.
2. Affect the acid test ratio to a greater degree than the current ratio.
3. Affect the current and acid test ratios to the same degree.
4. Affect the current ratio, but not the acid test ratio.
5. Affect the acid test ratio, but not the current ratio.
Rare Earth Clothing is a retail store specializing in women’s clothing. The store has established a liberal return policy for the holiday season in order to encourage gift purchases. Any item purchased during November and December may be returned through January 31, with a receipt, for cash or exchange. If the customer does not have a receipt, cash will still be refunded for any item under $100. If the item is more than $100, a check is mailed to the customer.
Whenever an item is returned, a store clerk completes a return slip, which the customer signs. The return slip is placed in a special box. The store manager visits the return counter approximately once every two hours to authorize the return slips. Clerks are instructed to place the returned merchandise on the proper rack on the selling floor as soon as possible.
This year, returns at Rare Earth Clothing have reached an all time high. There are a large number of returns under $100 without receipts.
a. How can sales clerks employed at Rare Earth Clothing use the store’s return policy to steal money from the cash register?
b. What internal control weaknesses do you see in the return policy that make cash thefts easier?
c. Would issuing a store credit in place of a cash refund for all merchandise returned without a receipt reduce the possibility of theft? List some advantages and disadvantages of issuing a store credit in place of a cash refund.
d. Assume that Rare Earth Clothing is committed to the current policy of issuing cash refunds without a receipt. What changes could be made in the store’s procedures regarding customer refunds in order to improve internal control?
Clear Voice Company, a communications equipment manufacturer, recently fell victim to a fraud scheme developed by one of its employees. To understand the scheme, it is necessary to review Clear Voice’s procedures for the purchase of services. The purchasing agent is responsible for ordering services (such as repairs to a photocopy machine or office cleaning) after receiving a service requisition from an authorized manager. However, since no tangible goods are delivered, a receiving report is not prepared. When the Accounting Department receives an invoice billing Clear Voice for a service call, the accounts payable clerk calls the manager who requested the service in order to verify that it was performed.
The fraud scheme involves Dana Foley, the manager of plant and facilities. Dana arranged for her uncle’s company, Foley Industrial Supply and Service, to be placed on Clear Voice’s approved vendor list. Dana did not disclose the family relationship. On several occasions, Dana would submit a requisition for services to be provided by Foley Industrial Supply and Service. However, the service requested was really not needed, and it was never performed. Foley would bill Clear Voice for the service and then split the cash payment with Dana. Explain what changes should be made to Clear Voice’s procedures for ordering and paying for services in order to prevent such occurrences in the future.
Uranium Mining Company, founded in 1982 to mine and market uranium, purchased a mine in 1983 for $900 million. It estimated that the uranium had a market value of $150 per ounce.
By 2010, the market value had increased to $300 per ounce. Records for 2010 indicate the following:
Production
200,000 ounces
Sales
230,000 ounces
Deliveries
190,000 ounces
Cash collection
210,000 ounces
Costs of production including depletion*
$50,000,000
Selling expense
$2,000,000
Administrative expenses
$1,250,000
Tax rate
50%
*Production cost per ounce has remained constant over the last few years, and the company has maintained the same production level.
Required
a. Compute the income for 2010, using each of the following bases:
1. Receipt of cash
2. Point of sale
3. End of production
4. Based on delivery
b. Comment on when each of the methods should be used. Which method should Uranium Mining Company use?
Each of the following statements represents a decision made by the accountant of Growth Industries:
a. A tornado destroyed $200,000 in uninsured inventory. This loss is included in the cost of goods sold.
b. Land was purchased 10 years ago for $50,000. The accountant adjusts the land account to $100,000, which is the estimated current value.
c. The cost of machinery and equipment is charged to a fixed asset account. The machinery and equipment will be expensed over the period of use.
d. The value of equipment increased this year, so no depreciation of equipment was recorded this year.
e. During the year, inventory that cost $5,000 was stolen by employees. This loss has been included in the cost of goods sold for the financial statements. The total amount of the cost of goods sold was $1 million.
f. The president of the company, who owns the business, used company funds to buy a car for personal use. The car was recorded on the company’s books.
Required
State whether you agree or disagree with each decision.
Which of the following is true when a cash dividend is declared and paid?
1. The firm is left with a liability to pay the dividend.
2. Retained earnings is reduced by the amount of the dividend.
3. Retained earnings is increased by the amount of the dividend.
4. Retained earnings is not influenced by the dividend.
5. Stockholders’ equity is increased.
Which of the following is true when a 10% stock dividend is declared and distributed?
1. Retained earnings is increased.
2. Stockholders’ equity is increased.
3. Stockholders’ equity is decreased.
4. Authorized shares are increased.
The overall effect is to leave stockholders’ equity in total and each owner’s share of stockholders’ equity is unchanged; however, the total number of shares increases.
Net income–noncontrolling interest comes from which of the following situations? 1. A company has been consolidated with our income statement, and our company owns less than 100% of the other company.
2. A company has been consolidated with our income statement, and our company owns 100% of the other company.
3. Our company owns less than 100% of another company, and the statements are not consolidated.
4. Our company owns 100% of another company, and the statements are not consolidated.
5. None of the above
Which of the following will not be disclosed in retained earnings?
The stockholders’ equity of Gaffney Company at November 30, 2010, is presented below.
Common stock, par value $5, authorized 200,000 shares, 100,000 shares issued and outstanding
$500,000
Paidin capital in excess of par
100,000
Retained earnings
300,000
$900,000
On December 1, 2010, the board of directors of Gaffney Company declared a 5% stock dividend, to be distributed on December 20. The market price of the common stock was $10 on December 1 and $12 on December 20. What is the amount of the change to retained earnings as a result of the declaration and distribution of this stock dividend?
Schroeder Company had 200,000 shares of common stock outstanding with a $2 par value and retained earnings of $90,000. In 2008, earnings per share were $0.50. In 2009, the company split the stock 2 for 1. Which of the following would result from the stock split?
1. Retained earnings will decrease as a result of the stock split.
2. A total of 400,000 shares of common stock will be outstanding.
3. The par value would become $4 par.
4. Retained earnings will increase as a result of the stock split.
5. None of the above
Which of the following is not a category within accumulated other comprehensive income?
1. Foreign currency translation adjustments
2. Unrealized holding gains and losses on availableforsale marketable securities
3. Changes to stockholders’ equity resulting from additional minimum pension liability
4. Unrealized gains and losses from derivative instruments
LENNAR CORPORATION AND SUBSIDIARIES* CONSOLIDATED STATEMENTS OF OPERATIONS Years Ended November 30, 2008, 2007, and 2006
2008
2007
2006
Revenues:
(Dollars in thousands, except per share amounts)
Homebuilding
$4,263,038
9,730,252
15,623,040
Financial services
312,379
456,529
643,622
Total revenues
4,575,417
10,186,781
16,266,662
Costs and expenses:
Homebuilding (1)
4,541,881
12,189,077
14,677,565
Financial services (2)
343,369
450,409
493,819
Corporate general and administrative
129,752
173,202
193,307
Total costs and expenses
5,015,002
12,812,688
15,364,691
Gain on recapitalization of unconsolidated entity
133,097
175,879
—
Goodwill impairments
—
190,198
—
Equity in loss from unconsolidated entities (3)
59,156
362,899
12,536
Management fees and other income (expense), net (4)
199,981
76,029
66,629
Minority interest income (expense), net
4,097
1,927
13,415
561,528
3,081,081
942,649
Earnings (loss) before (provision) benefit for income taxes (Provision) benefit for income taxes (5)
547,557
1,140,000
348,780
Net earnings (loss)
$1,109,085
1,941,081
593,869
Basic earnings (loss) per share
($7.00)
12.31
3.76
Diluted earnings (loss) per share
($7.00)
12.31
3.69
(1) Homebuilding costs and expenses include $340.5 million, $2,445.1 million, and $501.8 million, respectively, of valuation adjustments and writeoffs of option deposits and preacquisition costs for the years ended November 30, 2008, 2007 and 2006.
(2) Financial Services costs and expenses for the year ended November 30, 2008 include a $27.2 million impairment of goodwill.
(3) Equity in loss from unconsolidated entities includes $32.2 million, $364.2 million, and 126.4 million, respectively, of the Company’s share of SFAS 144 valuation adjustments related to assets of unconsolidated entities in which the Company has investments for the years ended November 30, 2008, 2007, and 2006.
(4) Management fees and other income (expense), net includes $172.8 million, $132.2 million, and $14.5 million, respectively, of APB 18 valuation adjustments to the Company’s investments in unconsolidated entities for the years ended November 30, 2008, 2007, and 2006.
(5) (Provision) benefit for income taxes for the year ended November 30, 2008 includes a valuation allowance of $730.8 million that the Company recorded against its deferred tax assets.
Required
a. Would you consider the presentation to be a multiplestep income statement or a singlestep income statement? Comment.
b. Does it appear that there is a 100% ownership in all consolidated subsidiaries?
c. If a subsidiary were not consolidated but rather accounted for using the equity method, would this change net earnings (loss)? Explain.
d. Describe equity in loss from unconsolidated entities (see Note 3).
e. Comment on Note 1. Does this note project favorably on the future of Lennar Corporation? Explain.
f. Comment on Note 2. Why take an impairment for goodwill under financial services? Why is this goodwill impairment disclosed separately from the line item goodwill impairments for 2007 ($190,198,000)?
MOTOROLA, INC., AND SUBSIDIARIES* CONSOLIDATED STATEMENTS OF OPERATIONS (IN PART)
Years Ended December 31,
(In millions, except per share amounts)
2008
2007
2006
Net sales
$30,146
$36,622
$42,847
Cost of sales
21,751
26,670
30,120
Gross margin
8,395
9,952
12,727
Selling, general, and administrative expenses
4,330
5,092
4,504
Research and development expenditures
4,109
4,429
4,106
Other charges
2,347
984
25
Operating earnings (loss)
2,391
553
4,092
Other income (expense):
Interest income, net
48
91
326
Gains on sales of investments and businesses, net
82
50
41
Other
376
22
151
Total other income (expense)
246
163
518
Earnings (loss) from continuing operations before income taxes
2,637
390
4,610
Income tax expense (benefit)
1,607
285
1,349
Earnings (loss) from continuing operations
4,244
105
3,261
Earnings from discontinued operations, net of tax
—
56
400
Net earnings (loss)
($4,244)
($49)
$3,661
Earnings (loss) per common share:
Basic:
Continuing operations
($1.87)
($0.05)
$1.33
Discontinued operations
—
0.03
0.17
($1.87)
($0.02)
$1.50
Diluted:
Continuing operations
($1.87)
($0.05)
$1.30
Discontinued operations
—
0.03
0.16
($1.87)
($0.05)
$1.46
Weighted average common shares outstanding:
Basic
2,265.40
2,312.70
2,446.30
Diluted
2,265.40
2,312.70
2,504.20
Dividends paid per share
$0.20
$0.20
$0.18
See accompanying notes to consolidated financial statements.
3. Other Financial Data (In Part) Statement of Operations Information Other Charges Other charges included in Operating earnings (loss) consist of the following:
Years Ended December 31
2008
2007
2006
Other charges (income):
Goodwill impairment
$1,619
$
$
Intangibles amortization
318
369
100
Reorganization of business
248
290
172
Asset impairments
136
89
—
Separationrelated transaction costs
59
—
—
Legal settlements and related insurance matters, net
14
140
50
Inprocess research and development charges
1
96
33
Gain on sale of property, plant and equipment
48
—
—
Charitable contribution to Motorola Foundation
—
—
88
Settlements and collections related to Telsim
—
—
418
$2,347
$984
$25
Other Income (Expense) Interest income, net, and Other both included in Other income (expense) consist of the following:
Years Ended December 31
2008
2007
2006
Interest income, net:
Interest income
$272
$456
$661
Interest expense
224
365
335
$48
$91
$326
Other:
Investment impairments
($365)
($44)
($27)
Impairment charges in Sigma Fund investments
186
18
—
Temporary unrealized losses of the Sigma Fund investments
101
—
—
Foreign currency gain (loss)
84
97
60
U.S. pension plan freeze curtailment gain
237
—
—
Liability extinguishment gain
56
—
—
Gain on interest rate swaps
24
—
—
Gain on Spring Nextel derivatives
—
—
99
Other
43
13
19
($376)
$22
$151
Required
a. Would you consider the presentation to be a multiple step income statement or a single step income statement? Comment.
b. Does it appear that there is a 100% ownership in all consolidated subsidiaries?
c. If a subsidiary were not consolidated but rather accounted for using the equity method, would this change net earnings (loss)? Explain.
d. 1. Comment on the goodwill impairment. What does this imply?
2. Comment on the investment impairments. What does this imply?
3. How significant are these impairments in relation to earnings (loss) from continuing operations before income taxes?
e. 1. How significant is selling, general, and administrative expenses in relation to gross margin?
2. How significant is research and development expenditures in relation to gross margin?
3. How significant are dividends paid in relation to net earnings (loss)?
4. a. Considering the above items, which one would you reduce first?
b. Considering the above items, which one would you protect the most?
PERRY ELLIS INTERNATIONAL, INC., AND SUBSIDIARIES* CONSOLIDATED STATEMENTS OF OPERATIONS For The Years Ended January 31, (Amounts in thousands, except per share data)
2009
2008
2007
Revenues
Net sales
$825,868
$838,465
$807,616
Royalty income
25,429
25,401
22,226
Total revenues
851,297
863,866
829,842
Cost of sales
573,046
572,232
554,046
Gross profit
278,251
291,634
275,796
Operating expenses
Selling, general, and administrative expenses
236,840
215,873
204,883
Depreciation and amortization
14,784
13,278
11,608
Impairment on longlived assets
22,299
—
—
Total operating expenses
273,923
229,151
216,491
Operating income
4,328
62,483
59,305
Costs on early extinguishment of debt
—
—
2,963
Impairment on marketable securities
2,797
—
—
Interest expense
17,491
17,594
21,114
(Loss) income before minority interest and income tax provision
15,960
Minority interest
612
44,889
35,228
Income tax (benefit) provision
3,682
931
508
Net (loss) income
($12,890)
15,785
12,311
Net (loss) income per share
$28,173
$22,409
Basic
($0.89)
$1.92
$1.55
Diluted
($0.89)
$1.80
$ 1,45
Weighted average number of shares outstanding
Basic
14,416
14,675
14,504
Diluted
14,416
14,657
15,455
See footnotes to consolidated financial statements.
PERRY ELLIS INTERNATIONAL, INC. AND SUBSIDIARIES
FOOTNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Part)
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JANUARY 31, 2009
2. Summary of Significant Accounting Policies (In Part)
The following is a summary of the Company’s significant accounting policies:
PRINCIPLES OF CONSOLIDATION—The consolidated financial statements include the accounts of Perry Ellis International, Inc., and its whollyowned and controlled subsidiaries. All intercompany transactions and balances have been eliminated in consolidation. The ownership interest in consolidated subsidiaries of noncontrolling shareholders is reflected as minority interest. The Company’s consolidation principles would also consolidate any entity in which the Company would be deemed a primary beneficiary.
USE OF ESTIMATES—The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts in the consolidated financial statements and the accompanying footnotes. Actual results could differ from those estimates.
Required
a. 1. Comment on the principles of consolidation.
2. Does it appear that there is a 100% ownership in all consolidated subsidiaries?
b. Comment on the use of estimates.
c. Would you expect an impairment in marketable securities?
d. What type of ‘‘special item’’ would be costs on early extinguishment debt?
On October 15, 1990, United Airlines (UAL Corporation) placed the largest widebody aircraft order in commercial aviation history—60 Boeing 747400s and 68 Boeing 777s—with an estimated value of $22 billion. With this order, United became the launch customer for the B777. This order was equally split between firm orders and options.
Required
a. Comment on when United Airlines should record the purchase of these planes.
b. Comment on when Boeing should record the revenue from selling these planes.
c. Speculate on how firm the commitment was on the part of United Airlines to accept delivery of these planes.
d. 1. Speculate on the disclosure for this order in the 1990 financial statements and notes of United Airlines.
2. Speculate on the disclosure for this order in the 1990 annual report of United Airlines. (Exclude the financial statements and notes.)
e. 1. Speculate on the disclosure for this order in the 1990 financial statements and notes of Boeing.
2. Speculate on the disclosure for this order in the 1990 annual report of Boeing. (Exclude the financial statements and notes.)
D. R. HORTON, INC.,* AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
September 30,
2008
2007
(In millions)
ASSETS
Homebuilding:
Cash and cash equivalents
$1,355.60
$228.30
Inventories:
Construction in progress and finished homes
1,681.60
3,346.80
Residential land and lots developed and under development
2,409.60
5,334.70
Land held for development
531.7
540.1
Land inventory not owned
60.3
121.9
4,683.20
9,343.50
Property and equipment, net
65.9
110.2
Income taxes receivable
676.2
—
Deferred income taxes, net of valuation allowance of $961.3 million and $4.7 million at September 30, 2008 and 2007, respectively
213.5
863.8
Earnest money deposits and other assets
247.5
291.2
Goodwill
15.9
95.3
7,257.80
10,932.30
Financial Services:
Cash and cash equivalents
31.7
41.3
Mortgage loans held for sale
352.1
523.5
Other assets
68
59.2
451.8
624
Total assets
$7,709.60
$11,556.30
LIABILITIES
Homebuilding:
Accounts payable
$254.00
$566.20
Accrued expenses and other liabilities
814.9
933.3
Notes payable
3,544.90
3,989.00
4,613.80
5,488.50
Financial Services:
Accounts payable and other liabilities
27.5
24.7
Repurchase agreement and notes payable to financial institutions
203.5
387.8
231
412.5
4,844.80
5,901.00
Commitments and contingencies (Note L)
Minority interests
30.5
68.4
Preferred stock, $.10 par value, 30,000,000 shares authorized, no shares issued
—
—
Common stock, $.01 par value, 1,000,000,000 shares authorized, 320,315,508 shares issued and 316,660,275 shares outstanding 314,914,440 shares outstanding at September 30, 2007
3.2
3.2
Additional capital
1,716.30
1,693.30
Retained earnings
1,210.50
3,986.10
Treasury stock, 3,655,233 shares at September 30, 2008 and 2007, at cost
95.7
95.7
2,834.30
5,586.90
Total liabilities and stockholders’ equity
$7,709.60
$11,556.30
D. R. HORTON, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended September 30,
2008
2007
2006
(In millions, except per share data)
Homebuilding:
Revenues:
Home sales
$6,164.30
$10,721.20
$14,545.40
Land/lot sales
354.3
367.6
215.1
6,518.60
11,088.80
14,760.50
Cost of sales:
Home sales
5,473.10
8,872.30
11,047.80
Land/lot sales
324.2
283.3
99.6
Inventory impairments and land option cost writeoffs
2,484.50
1,329.50
270.9
8,281.80
10,485.10
11,418.30
Gross profit (loss):
Home sales
691.2
1,848.90
3,497.60
Land/lot sales
30.1
84.3
115.5
Inventory impairments and land option cost writeoffs
2,484.50
1,329.50
270.9
1,763.20
603.7
3,342.20
Selling, general, and administrative expense
791.8
1,141.50
1,456.60
Goodwill impairment
79.4
474.1
—
Interest expense
39
—
—
Loss on early retirement of debt
2.6
12.1
17.9
Other (income)
9.1
4
11
2,666.90
1,202.00
1,878.70
Financial Services:
Revenues
127.5
207.7
290.8
General and administrative expense
100.1
153.8
202.2
Interest expense
3.7
23.6
37.1
Interest and other (income)
11.4
38.5
56.9
35.1
68.8
108.4
Income (loss) before income taxes
2,631.80
951.2
1,987.10
Provision for (benefit from) income taxes
1.8
238.7
753.8
Net income (loss)
($2,633.60)
($712.50)
$1,233.30
Basic net income (loss) per common share
($8.34)
($2.27)
$3.94
Net income (loss) per common share assuming dilution
($8.34)
($2.27)
$3.90
Cash dividends declared per common share
$0.45
$0.60
$0.44
Land and development costs are typically allocated to individual residential lots on a prorata basis, and the costs of residential lots are transferred to construction in progress when home construction begins. The specific identification method is used for the purpose of accumulating home construction costs. Cost of sales for homes closed includes the specific construction costs of each home and all applicable land acquisition, land development, and related costs (both incurred and estimated to be incurred) based on the total number of homes expected to be closed in each community. Any changes to the estimated total development costs subsequent to the initial home closings in a community are generally allocated on a prorata basis to the remaining homes in the community. When a home is closed, the Company generally has not yet paid and recorded all incurred costs necessary to complete the home. Each month a liability and a charge to cost of sales is recorded for the amount that is determined will ultimately be paid related to completed homes that have been closed as of the end of that month. The home construction budgets are compared to actual recorded costs to determine the additional costs remaining to be paid on each closed home. The accuracy of each month’s accrual is monitored by comparing actual costs incurred on closed homes in subsequent months to the amount previously accrued. Although actual costs to be paid in the future on previously closed homes could differ from the Company’s current accruals, historically, differences in amounts have not been significant.
Each quarter, all components of inventory are reviewed for the purpose of determining whether recorded costs and costs required to complete each home or project are recoverable. If the review indicates that an impairment loss is required under the guidelines of SFAS No. 144, ‘‘Accounting for the Impairment or Disposal of LongLived Assets,’’ an estimate of the loss is made and recorded to cost of sales in that quarter.
Required
a. 1. Are inventories classified as a current asset? Comment.
2. Does it appear that inventories are a highly liquid asset?
b. 1. Goodwill impairment—what does this imply?
2. Comment on the review of inventory for impairments. Why is this done under the guidelines of SFAS No. 144, ‘‘Accounting for the impairment or disposal of longlived assets.’’?
c. 1. Why restricted cash? Can this cash be used in operations?
2. Comment on the impairments and the use of cash.
3. Do you think that cash dividends will be eliminated? Comment.
Shaw Communications, Inc.* included this information in its 2008 annual report.
Notes to Consolidated Financial Statements (In Part)
August 31, 2008, 2007, and 2006
(all amounts in thousands of Canadian dollars except share and per share amounts)
21. United States Generally Accepted Accounting Principles (In Part) The consolidated financial statements of the Company are prepared in Canadian dollars in accordance with Canadian GAAP. The following adjustments and disclosures would be required in order to present these consolidated financial statements in accordance with U.S. GAAP. (a) Reconciliation to U.S. GAAP
2008 $
2007 $
2006 $
Net income using Canadian GAAP
671,562
388,479
458,250
Add (deduct) adjustments for:
Deferred charges and credits(2)
18,808
5,672
15,362
Foreign exchange gains on hedged longterm debt(3)
—
47,382
78,937
Reclassification of hedge losses from other comprehensive income(8)
—
47,382
78,937
Capitalized interest(11)
4,133
2,244
—
Income taxes(12)
2,048
10,461
8,990
Net income using US GAAP
654,839
385,934
464,622
Unrealized foreign exchange loss on translation of a selfsustaining foreign operation
—
18
35
Reclassification adjustments for gains on availableforsale securities included in net income(7)
—
—
29,728
Adjustment to fair value of derivatives(8)
—
5,730
62,843
Reclassification of derivative losses to income to offset foreign exchange gains on hedged longterm debt(8)
—
40,215
74,632
Change in funded status of noncontributory defined pension plan(10)
Minimum liability for pension plan
3,135
—
—
—
5,813
2,848
Comprehensive income using US GAAP
3,135
51,740
15,126
Earnings per share using US GAAP
651,704
437,674
449,496
Basic
1.52
0.89
1.07
Diluted
1.51
0.89
1.07
Required
a. Observe net income using Canadian GAAP vs. net income using U.S. GAAP, and comprehensive income using U.S. GAAP. Comment on the materiality of the difference between these numbers.
b. Observe the statements are in Canadian dollars. Would there be a significant difference between using Canadian dollars and U.S. dollars? Comment.
China Unicom (Hong Kong) Limited provides a full range of telecommunications services, including mobile and fixed line service, in China.
They are listed on the New York Stock Exchange and filed as Form 20F with the SEC for the period ended December 31, 2008. The consolidated income statement is presented with this case.
CHINA UNICOM (HONG KONG) LIMITED CONSOLIDATED STATEMENTS OF INCOME For the Years Ended December 31, 2007 and 2008 (Expressed in millions, except per share data)
Note
2007 As restated (Note 2.2)
2008
2008
RMB
RMB
US$
Continuing operations
Revenue
5, 26
150,687
148,906
21,826
Interconnection charges
11,214
12,011
1,761
Depreciation and amortization
47,369
47,678
6,988
Networks, operations, and support expenses
28
16,022
16,577
2,430
Employee benefit expenses
31
17,540
18,902
2,771
Other operating expenses
29
32,776
33,582
4,922
Finance costs
30
3,231
2,411
353
Interest income
285
239
35
Impairment loss on property, plant and equipment
6
—
11,837
1,735
Realized loss on changes in fair value of derivative component of the convertible bonds
21
569
—
—
Other income net
27
4,990
1,994
292
Income from continuing operations before income tax
27,241
8,141
1,193
Income tax expenses
9
7,083
1,801
264
Income from continuing operations
20,158
6,340
929
Discontinued operations
Income from discontinued operations
33
654
1,438
211
Gain on the disposal of discontinued operations
33
626
26,135
3,831
Net income
21,438
33,913
4,971
Attributable to:
Equity holders of the Company
21,437
33,912
4,971
Minority interest
1
1
—
21,438
33,913
4,971
Proposed final dividend
34
6,427
4,754
697
Dividend paid during the year
34
5,885
6,231
913
Note
2007 As restated (Note 2.2)
2008
2008
RMB
RMB
US$
Earnings per share for income attributable to the equity holders of the Company during the year
Basic earnings per share
35
0.93
1.43
0.21
Diluted earnings per share
35
0.92
1.42
0.21
Earnings per share for the income from continuing operations attributable to the equity holders of the Company during the year
Basic earnings per share
35
0.87
0.27
0.04
Diluted earnings per share
35
0.86
0.27
0.04
Earnings per share for income from discontinued operations attributable to the equity holders of the Company during the year
Basic earnings per share
35
0.06
1.16
0.17
Diluted earnings per share
35
0.06
1.15
0.17
Required
a. Consolidated income statement
1. Why presented in RMB and U.S. $?
2. Is the statement presented by function or nature?
3. Comment on the presentation relating net income to ‘‘attributable to.’’
4. Why is earnings per share attributable to the equity holders?
5. Comment on the dividend paid during the year being presented in the income statement (proposed final dividend and dividends paid during the year).
The beginning inventory at Continental Office Supplies and data on purchases and sales for a three month period are as follows:
Number
Per
Date
Transaction
of Units
Unit
Total
Jan.
1
Inventory
50
$20.00
$1,000
7
Purchase
200
22.00
4,400
20
Sale
90
40.00
3,600
30
Sale
110
40.00
4,400
Feb.
8
Sale
20
44.00
880
10
Purchase
130
23.00
2,990
27
Sale
90
42.00
3,780
28
Sale
50
45.00
2,250
Mar.
5
Purchase
180
24.00
4,320
13
Sale
90
50.00
4,500
23
Purchase
100
26.00
2,600
30
Sale
80
50.00
4,000
Instructions
1. Record the inventory, purchases, and cost of merchandise sold data in a perpetual inventory record similar to the one illustrated in Exhibit 3, using the first in, first out method.
2. Determine the total sales and the total cost of merchandise sold for the period. Journalize the entries in the sales and cost of merchandise sold accounts. Assume that all sales were on account.
3. Determine the gross profit from sales for the period.
Del Mar Appliances uses the periodic inventory system. Details regarding the inventory of appliances at August 1, 2007, purchases invoices during the year, and the inventory count at July 31, 2008, are summarized as follows:
Inventory,
Purchases In
Inventory Count,
Model
August 1
1st
2nd
3rd
July 31
T742
2 at $125
2 at $130
4 at $135
2 at $140
5
PM18
7 at 242
6 at 250
5 at 260
10 at 259
9
K21G
6 at 80
5 at 82
8 at 89
8 at 90
6
H60W
2 at 108
2 at 110
3 at 128
3 at 130
5
B153Z
8 at 88
4 at 79
3 at 85
6 at 92
8
J600T
5 at 160
4 at 170
4 at 175
7 at 180
8
C273W
—
4 at 75
4 at 100
4 at 101
5
Instructions
1. Determine the cost of the inventory on July 31, 2008, by the first in, first out method.
Present data in columnar form, using the following headings:
Model
Quantity
Unit Cost
Total Cost
If the inventory of a particular model comprises one entire purchase plus a portion of another purchase acquired at a different unit cost, use a separate line for each purchase. 2. Determine the cost of the inventory on July 31, 2008, by the last in, first out method, following the procedures indicated in (1).
3. Determine the cost of the inventory on July 31, 2008, by the average cost method, using the columnar headings indicated in (1).
4. Discuss which method (FIFO or LIFO) would be preferred for income tax purposes in periods of (a) rising prices and (b) declining prices.
Data on the physical inventory of Exchange Company as of December 31, 2008, are presented in the working papers. The quantity of each commodity on hand has been determined and recorded on the inventory sheet. Unit market prices have also been determined as of December 31 and recorded on the sheet. The inventory is to be determined at cost and also at the lower of cost or market, using the first in, first out method. Quantity and cost data from the last purchases invoice of the year and the next to the last purchases invoice are summarized as follows:
Last
Next to the Last
Purchases Invoice
Purchases Invoice
Quantity
Unit
Quantity
Unit
Description
Purchased
Cost
Purchased
Cost
AC172
25
$ 60
30
$ 58
BE43
35
175
20
180
CJ9
18
130
25
128
E34
150
25
100
24
F17
10
565
10
560
G68
100
15
100
14
K41
10
385
5
384
Q79
500
6
500
6
RZ13
80
22
50
21
S60
5
250
4
260
W21
100
20
75
19
XR90
9
750
9
740
Instructions
Record the appropriate unit costs on the inventory sheet, and complete the pricing of the inventory.
When there are two different unit costs applicable to an item, proceed as follows:
1. Draw a line through the quantity, and insert the quantity and unit cost of the last purchase.
2. On the following line, insert the quantity and unit cost of the next to the last purchase.
3. Total the cost and market columns and insert the lower of the two totals in the Lower of C or M column. The first item on the inventory sheet has been completed as an example.
Selected data on merchandise inventory, purchases, and sales for Hacienda Co. and San Lucas Co. are as follow
Cost
Retail
Hacienda Co.
Merchandise inventory, June 1
$ 200,000
$ 290,000
Transactions during June:
Purchases (net)
2,086,000
2,885,000
Sales
2,780,000
Sales returns and allowances
30,000
San Lucas Co.
Merchandise inventory, November 1
$ 225,000
Transactions during November and December:
Purchases (net)
1,685,000
Sales
2,815,000
Sales returns and allowances
85,000
Estimated gross profit rate
40%
Instructions
1. Determine the estimated cost of the merchandise inventory of Hacienda Co. on June 30 by the retail method, presenting details of the computations.
2. a. Estimate the cost of the merchandise inventory of San Lucas Co. on December 31 by the gross profit method, presenting details of the computations.
b. Assume that San Lucas Co. took a physical inventory on December 31 and discovered that $269,250 of merchandise was on hand. What was the estimated loss of inventory due to theft or damage during November and December?
The beginning inventory of merchandise at Citrine Co. and data on purchases and sales for a three month period are as follows:
Number
Per
Date
Transaction
of Units
Unit
Total
March
1
Inventory
132
$1,500
$198,000
8
Purchase
108
2,000
216,000
11
Sale
72
4,800
345,600
22
Sale
66
4,800
316,800
April
3
Purchase
96
2,300
220,800
10
Sale
60
5,000
300,000
21
Sale
30
5,000
150,000
30
Purchase
120
2,350
282,000
May
5
Sale
120
5,250
630,000
13
Sale
72
5,250
378,000
21
Purchase
180
2,400
432,000
28
Sale
90
5,400
486,000
Instructions
1. Record the inventory, purchases, and cost of merchandise sold data in a perpetual inventory record similar to the one illustrated in Exhibit 3, using the first in, first out method.
2. Determine the total sales and the total cost of merchandise sold for the period. Journalize the entries in the sales and cost of merchandise sold accounts. Assume that all sales were on account.
3. Determine the gross profit from sales for the period.
The beginning inventory and data on purchases and sales for a three month period.
Number
Per
Date
Transaction
of Units
Unit
Total
March
1
Inventory
132
$1,500
$198,000
8
Purchase
108
2,000
216,000
11
Sale
72
4,800
345,600
22
Sale
66
4,800
316,800
April
3
Purchase
96
2,300
220,800
10
Sale
60
5,000
300,000
21
Sale
30
5,000
150,000
30
Purchase
120
2,350
282,000
May
5
Sale
120
5,250
630,000
13
Sale
72
5,250
378,000
21
Purchase
180
2,400
432,000
28
Sale
90
5,400
486,000
Instructions
1. Record the inventory, purchases, and cost of merchandise sold data in a perpetual inventory record similar to the one illustrated in Exhibit 4, using the last in, first out method.
2. Determine the total sales, the total cost of merchandise sold, and the gross profit from sales for the period.
Data on the physical inventory of Satchell Co. as of December 31, 2008, are presented in the working papers. The quantity of each commodity on hand has been determined and recorded on the inventory sheet. Unit market prices have also been determined as of December 31 and recorded on the sheet. The inventory is to be determined at cost and also at the lower of cost or market, using the first in, first out method. Quantity and cost data from the last purchases invoice of the year and the next to the last purchases invoice are summarized as follows:
Last
Next to the Last
Purchases Invoice
Purchases Invoice
Quantity
Unit
Quantity
Unit
Description
Purchased
Cost
Purchased
Cost
AC172
30
$ 60
40
$ 59
BE43
25
175
15
180
CJ9
20
130
15
128
E34
150
25
100
27
F17
6
550
15
540
G68
75
14
100
13
K41
8
400
4
398
Q79
500
6
500
7
RZ13
65
22
50
21
S60
5
250
4
260
W21
120
20
115
17
XR90
10
750
8
740
Instructions
Record the appropriate unit costs on the inventory sheet, and complete the pricing of the inventory. When there are two different unit costs applicable to an item:
1. Draw a line through the quantity, and insert the quantity and unit cost of the last purchase.
2. On the following line, insert the quantity and unit cost of the next to the last purchase.
3. Total the cost and market columns and insert the lower of the two totals in the Lower of C or M column. The first item on the inventory sheet has been completed as an example.
Selected data on merchandise inventory, purchases, and sales for Miramar Co. and Boyar’s Co. are as follows:
Cost
Retail
Miramar Co.
Merchandise inventory, March 1
$ 185,000
$ 280,000
Transactions during March:
Purchases (net)
2,246,000
3,295,000
Sales
3,360,000
Sales returns and allowances
60,000
Boyar’s Co.
Merchandise inventory, August 1
$ 425,000
Transactions during August and September:
Purchases (net)
2,980,000
Sales
5,075,000
Sales returns and allowances
75,000
Estimated gross profit rate
40%
Instructions
1. Determine the estimated cost of the merchandise inventory of Miramar Co. on March 31 by the retail method, presenting details of the computations.
2. a. Estimate the cost of the merchandise inventory of Boyar’s Co. on September 30 by the gross profit method, presenting details of the computations.
b. Assume that Boyar’s Co. took a physical inventory on September 30 and discovered that $398,250 of merchandise was on hand. What was the estimated loss of inventory due to theft or damage during August and September?
The following is an excerpt from a conversation between Jack O’Brien, the warehouse manager for Murrieta Wholesale Co., and its accountant, Carole Timmons. Murrieta Wholesale operates a large regional warehouse that supplies produce and other grocery products to grocery stores in smaller communities.
Jack: Carole, can you explain what’s going on here with these monthly statements?
Carole: Sure, Jack. How can I help you?
Jack: I don’t understand this last in, first out inventory procedure. It just doesn’t make sense.
Carole: Well, what it means is that we assume that the last goods we receive are the first ones sold. So the inventory is made up of the items we purchased first.
Jack: Yes, but that’s my problem. It doesn’t work that way! We always distribute the oldest produce first. Some of that produce is perishable! We can’t keep any of it very long or it’ll spoil.
Carole: Jack, you don’t understand. We only assume that the products we distribute are the last ones received. We don’t actually have to distribute the goods in this way.
Jack: I always thought that accounting was supposed to show what really happened. It all sounds like “make believe” to me! Why not report what really happens?
Kowalski Company began operations in 2007 by selling a single product. Data on purchases and sales for the year were as follows:
Purchases:
Date
Units Purchased
Unit Cost
Total Cost
April 6
3,875
$12.20
$ 47,275
May 18
4,125
13.00
53,625
June 6
5,000
13.20
66,000
July 10
5,000
14.00
70,000
August 10
3,400
14.25
48,450
October 25
1,600
14.50
23,200
November 4
1,000
14.95
14,950
December 10
1,000
16.00
16,000
25,000
$339,500
Sales:
April
2,000 units
May
2,000
June
2,500
July
3,000
August
3,500
September
3,500
October
2,250
November
1,250
December
1,000
Total units Total sales
21,000 $325,000
On January 6, 2008, the president of the company, Jolly Zondra, asked for your advice on costing the 4,000 unit physical inventory that was taken on December 31, 2007. Moreover, since the firm plans to expand its product line, she asked for your advice on the use of a perpetual inventory system in the future.
1. Determine the cost of the December 31, 2007, inventory under the periodic system, using the (a) first in, first out method, (b) last in, first out method, and (c) average cost method.
2. Determine the gross profit for the year under each of the three methods in (1).
3. a. Explain varying viewpoints why each of the three inventory costing methods may best reflect the results of operations for 2007.
b. Which of the three inventory costing methods may best reflect the replacement cost of the inventory on the balance sheet as of December 31, 2007?
c. Which inventory costing method would you choose to use for income tax purposes? Why?
d. Discuss the advantages and disadvantages of using a perpetual inventory system. From the data presented in this case, is there any indication of the adequacy of inventory levels during the year?
Dell Inc. and Hewlett Packard Development Company, L.P. (HP) are both manufacturers of computer equipment and peripherals. However, the two companies follow two different strategies. Dell follows a build to order strategy, where the consumer orders the computer from a Web page. The order is then manufactured and shipped to the customer within days of the order. In contrast, HP follows a build to stock strategy, where the computer is first built for inventory, then sold from inventory to retailers, such as Best Buy. The two strategies can be seen in the difference between the inventory turnover and number of days’ sales in inventory ratios for the two companies. The following financial statement information is provided for Dell and HP for a recent fiscal year (in millions)
Dell
HP
Inventory, beginning of period
$ 327
$ 7,071
Inventory, end of period
459
6,877
Cost of goods sold
40,190
66,224
a. Determine the inventory turnover ratio and number of days’ sales in inventory ratio for each company. Round to one decimal place.
b. Interpret the difference between the ratios for the two companies.
The Neiman Marcus Group, Inc., is a high end specialty retailer, while Amazon.com uses its e commerce services, features, and technologies to sell its products through the Internet. Recent balance sheet inventory disclosures for Neiman Marcus and Amazon.com are as follows:
End of Period
Beginning of Period
Inventory
Inventory
Neiman Marcus Group, Inc.
$720,277,000
$687,062,000
Amazon.com
479,709,000
293,917,000
The cost of merchandise sold reported by each company was as follows:
Neiman Marcus Group, Inc.
Amazon.com
Cost of merchandise sold
$2,321,110,000
$5,319,127,000
a. Determine the inventory turnover and number of days’ sales in inventory for Neiman Marcus and Amazon.com.
The general merchandise retail industry has a number of segments represented by the following companies:
Company Name
Merchandise Concept
Costco Wholesale Corporation
Membership warehouse
Wal Mart
Discount general merchandise
JCPenney
Department store
For a recent year, the following cost of merchandise sold and beginning and ending inventories have been provided from corporate annual reports for these three companies:
Costco
Wal Mart
JCPenney
Cost of merchandise sold
$42,092
$219,793
$11,285
Merchandise inventory, beginning
3,339
26,612
3,156
Merchandise inventory, ending
3,644
29,447
3,169
a. Determine the inventory turnover ratio for all three companies. Round to one decimal place.
b. Determine the number of days’ sales in inventory for all three companies. Round to one decimal place.
c. Interpret these results based upon each company’s merchandise concept.
The following items may appear on a bank statement:
1. NSF check
2. EFT deposit
3. Service charge
4. Bank correction of an error from recording a $400 check as $40
Indicate whether the item would appear as a debit or credit memorandum on the bank statement and whether the item would increase or decrease the balance of the depositor’s account.
The following items may appear on a bank statement:
1. Service charge
2. Note collected for depositor
3. Bank correction of an error from recording a $2,100 deposit as $1,200
4. EFT payment
Using the format shown below, indicate whether each item would appear as a debit or credit memorandum on the bank statement and whether the item would increase or decrease the balance of your account.
The following items may appear on a bank statement:
1. Bank correction of an error from posting another customer’s check to your account
2. Loan proceeds
3. NSF check
4. EFT deposit
Using the format shown below, indicate whether each item would appear as a debit or credit memorandum on the bank statement and whether the item would increase or decrease the balance of your account.
Tyler Kirsch has recently been hired as the manager of Dark Canyon Coffee. Dark Canyon Coffee is a national chain of franchised coffee shops. During his first month as store manager, Tyler encountered the following internal control situations:
a. Dark Canyon Coffee has one cash register. Prior to Tyler’s joining the coffee shop, each employee working on a shift would take a customer order, accept payment, and then prepare the order. Tyler made one employee on each shift responsible for taking orders and accepting the customer’s payment. Other employees prepare the orders.
b. Since only one employee uses the cash register, that employee is responsible for counting the cash at the end of the shift and verifying that the cash in the drawer matches the amount of cash sales recorded by the cash register. Tyler expects each cashier to balance the drawer to the penny every time—no exceptions.
c. Tyler caught an employee putting a box of 100 single serving tea bags in his car. Not wanting to create a scene, Tyler smiled and said, “I don’t think you’re putting those tea bags on the right shelf. Don’t they belong inside the coffee shop?” The employee returned the tea bags to the stockroom.
State whether you agree or disagree with Tyler’s method of handling each situation and explain your answer.
The inventory at the end of the year was understated by $8,750. (a) Did the error cause an overstatement or an understatement of the gross profit for the year? (b) Which items on the balance sheet at the end of the year were overstated or understated as a result of the error?
Fargo Co. sold merchandise to Keepsakes Company on December 31, FOB shipping point. If the merchandise is in transit on December 31, the end of the fiscal year, which company would report it in its financial statements? Explain.
A manufacturer shipped merchandise to a retailer on a consignment basis. If the merchandise is unsold at the end of the period, in whose inventory should the merchandise be included?
What uses can be made of the estimate of the cost of inventory determined by the gross profit method?
Three identical units of Item T4W are purchased during July, as shown below.
Item T4W
Units
Cost
July 6
Purchase
1
$115
19
Purchase
1
118
24
Purchase
1
121
Total
3
$354
Average cost per unit
$118 ($354/3 units)
Assume that one unit is sold on July 28 for $150. Determine the gross profit for July and ending inventory on July 31 using the (a) first in, first out (FIFO); (b) last in, first out (LIFO); and (c) average cost methods.
Three identical units of Item S77 are purchased during October, as shown below.
Item S77
Units
Cost
Oct. 6
Purchase
1
$ 88
19
Purchase
1
85
24
Purchase
1
82
24
Total
3
$255
Average cost per unit
$ 85 ($255/3 units)
Assume that one unit is sold on October 26 for $100. Determine the gross profit for October and ending inventory on October 31 using the (a) first in, first out (FIFO); (b) last in, first out (LIFO); and (c) average cost methods.
Beginning inventory, purchases, and sales for Item SJ68 are as follows:
Aug. 1
Inventory
28 units at $34
8
Sale
15 units
15
Purchase
22 units at $38
30
Sale
20 units
Assuming a perpetual inventory system and using the first in, first out (FIFO) method, determine (a) the cost of merchandise sold on August 30 and (b) the inventory on August 31.
Beginning inventory, purchases, and sales for Item FC33 are as follows:
Mar. 1
Inventory
23 units at $10
8
Sale
18 units
15
Purchase
57 units at $14
29
Sale
40 units
Assuming a perpetual inventory system and using the first in, first out (FIFO) method, determine (a) the cost of merchandise sold on March 29 and (b) the inventory on March 31.
The units of an item available for sale during the year were as follows:
Jan. 1
Inventory
12 units at $25
$ 300
Apr. 20
Purchase
28 units at $30
840
Nov. 30
Purchase
40 units at $36
1,440
Available for sale
80 units
$2,580
There are 20 units of the item in the physical inventory at December 31. The periodic inventory system is used. Determine the inventory cost using (a) the first in, first out (FIFO) method; (b) the last in, first out (LIFO) method; and (c) the average cost method.
On the basis of the following data, determine the value of the inventory at the lower of cost or market. Apply lower of cost or market to each inventory item.
On the basis of the following data, determine the value of the inventory at the lower of cost or market. Apply lower of cost or market to each inventory item.
PacTec Luggage Shop is a small retail establishment located in a large shopping mall. This shop has implemented the following procedures regarding inventory items:
a. Since the display area of the store is limited, only a sample of each piece of luggage is kept on the selling floor. Whenever a customer selects a piece of luggage, the salesclerk gets the appropriate piece from the store’s stockroom. Since all salesclerks need access to the stockroom, it is not locked. The stockroom is adjacent to the break room used by all mall employees.
b. Whenever PacTec receives a shipment of new inventory, the items are taken directly to the stockroom. PacTec’s accountant uses the vendor’s invoice to record the amount of inventory received.
c. Since the shop carries mostly high quality, designer luggage, all inventory items are tagged with a control device that activates an alarm if a tagged item is removed from the store.
State whether each of these procedures is appropriate or inappropriate. If it is inappropriate, state why.
Beginning inventory, purchases, and sales data for portable MP3 players are as follows:
Nov. 1
Inventory
70 units at $40
5
Sale
52 units
16
Purchase
30 units at $42
21
Sale
24 units
24
Sale
8 units
30
Purchase
14 units at $45
The business maintains a perpetual inventory system, costing by the first in, first out method. Determine the cost of the merchandise sold for each sale and the inventory balance after each sale, presenting the data in the form illustrated in Exhibit 3.
Beginning inventory, purchases, and sales data for cell phones for July are as follows:
Inventory
Purchases
Sales
July 1
100 units at $30
July
3
80 units at $32
July 7
72 units
21
60 units at $33
13
80 units
31
32 units
Assuming that the perpetual inventory system is used, costing by the LIFO method, determine the cost of merchandise sold for each sale and the inventory balance after each sale, presenting the data in the form illustrated in Exhibit 4.
Assume that the business maintains a perpetual inventory system, costing by the first in, first out method. Determine the cost of merchandise sold for each sale and the inventory balance after each sale, presenting the data in the form illustrated in Exhibit 3.
The following units of a particular item were available for sale during the year:
Beginning inventory Sale
100 units at $60 75 units at $112
First purchase Sale
155 units at $65 135 units at $112
Second purchase Sale
200 units at $72 175 units at $112
The firm uses the perpetual inventory system, and there are 70 units of the item on hand at the end of the year. What is the total cost of the ending inventory according to (a) FIFO, (b) LIFO?
The units of an item available for sale during the year were as follows:
Jan. 1
Inventory
168 units at $60
Apr. 15
Purchase
232 units at $65
Sept. 3
Purchase
80 units at $68
Nov. 23
Purchase
120 units at $70
There are 140 units of the item in the physical inventory at December 31. The periodic inventory system is used. Determine the inventory cost and the cost of merchandise sold by three methods, presenting your answers in the following form:
On the basis of the following data, determine the value of the inventory at the lower of cost or market. Assemble the data in the form illustrated in Exhibit 7.
The following data were taken from recent annual reports of Apple Computer, Inc., a manufacturer of personal computers and related products, and American Greetings Corporation, a manufacturer and distributor of greeting cards and related products:
Apple
American Greetings
Cost of goods sold
$9,888,000,000
$905,201,000
Inventory, end of year
165,000,000
222,874,000
Inventory, beginning of the year
101,000,000
246,171,000
a. Determine the inventory turnover for Apple and American Greetings. Round to one decimal place.
b. Would you expect American Greetings’ inventory turnover to be higher or lower than Apple’s? Why?
In 2011 the city started and completed installation of curbs and sidewalks in a new subdivision. The project was funded through special assessments. The first $500,000 installment on $2,500,000 in special assessments was received and recorded in the capital projects fund in 2011. Over the next four years the remaining special assessments are due. How would the receipt of the special assessment funds be recorded in the capital projects fund in 2011?
General Capital Assets. Make all necessary entries in the appropriate governmental fund general journal and the government wide governmental activities general journal for each of the following transactions entered into by the City of Fordache.
1. The city received a donation of land that is to be used by Parks and Recreation for a park. At the time of the donation, the land had a fair value of $5,200,000 and was recorded on the donor’s books at a historical cost of $4,500,000.
2. The Public Works Department sold machinery with a historical cost of $35,100 and accumulated depreciation of $28,700 for $6,400. The machinery had originally been purchased with special revenue funds.
3. A car was leased for the mayor’s use. Since the term of the lease exceeded 75 percent of the useful life of the car, the lease was capitalized. The first payment was $550 and the present value of the remaining lease payments was $30,000.
4. During the current year, a capital projects fund completed a new public safety building that was started in the prior year. The total cost of the project was $9,720,000. Financing for the project came from a $9,000,000 bond issue that was sold in the prior year, and from a $720,000 federal capital grant received in the current year. Current year expenditures for the project totaled $1,176,000. The full cost is attributed to the building since it was constructed on city owned property.
5. Due to technological developments, the city determined that the service capacity of some of the technology equipment used by general government had been impaired. The calculated impairment loss due to technology obsolescence was $1,156,000.
Capital Asset Disclosures. Lynn County has prepared the following schedule related to its capital asset activity for the fiscal year 2011. Lynn County has governmental activities only, with no business type activities.
LYNN COUNTY Capital Asset Disclosures For the Year Ended December 31, 2011
January 1
Change
December 31
Total capital assets not being depreciated (land, infrastructure, and construction work in progress)
$61,721,000
$ 9,158,000
$70,879,000
Total capital assets being depreciated (buildings, equipment, and collections)
13,421,000
1,647,000
15,068,000
Less total accumulated depreciation
(3,464,000)
(558,000)
(4,022,000)
Capital assets, net
$71,678,000
$10,247,000
$81,925,000
Required
a. Does the above capital asset footnote disclosure comply with the GASB requirements? Explain.
b. Does the county use the modified approach to account for infrastructure assets? Explain.
c. What percentage of the useful life of the depreciable assets remains?
Capital Assets Acquired under Lease Agreements. Crystal City signed a lease agreement with East Coast Builders, Inc., under which East Coast will construct a new office building for the city at a cost of $12 million and lease it to the city for 30 years. The city agrees to make an initial payment of $847,637 and annual payments in the same amount for the next 29 years. An assumed borrowing rate of 6 percent was used in calculating lease payments. Upon completion, the building had an appraised market value of $13 million and an estimated life of 40 years.
Required
a. Using the criteria presented in this chapter, determine whether Crystal City should consider this lease agreement a capital lease. Explain your decision.
b. Provide the journal entries Crystal City should make for both the capital projects fund and governmental activities at the government wide level to record the lease at the date of inception.
Recording Capital Projects Fund Transactions. In Erikus County, the Parks and Recreation Department constructed a library in one of the county’s high growth areas. The construction was funded by a number of sources. Below is selected information related to the funding and closing of the Library Capital Project Fund. All activity related to the library construction occurred within the 2011 fiscal year.
1. The county issued $6,000,000, 4 percent bonds, with interest payable semiannually on June 30 and December 31. The bonds sold for 101 on July 30,2010. Proceeds from the bonds were to be used for construction of the library, with all interest and premiums received to be used to service the debt issue.
2. A $650,000 federal grant was received to help finance construction of the library.
3. The Library Special Revenue Fund transferred $250,000 for use in construction of the library.
4. A construction contract was awarded in the amount of $6,800,000.
5. The library was completed on June 1, 2011, four months ahead of schedule. Total construction expenditures for the library amounted to $6,890,000. When the project was completed, the cost of the library was allocated as follows: $200,000 to land, $6,295,000 to building, and the remainder to equipment.
6. The capital projects fund was closed. It was determined that remaining funds were related to the bond issue, and thus they were appropriately transferred to the debt service fund.
Required
Make all necessary entries in the capital projects fund general journal and the governmental activities general journal at the government wide level.
Statement of Revenues, Expenditures, and Changes in Fund Balance. The pre closing trial balance for the Annette County Public Works Capital Project Fund is provided below.
Debits
Credits
Cash
$ 701,000
Grant Receivable
500,000
Investments
800,000
Contract Payable
$ 835,000
Contract Payable—Retained Percentage
24,000
Reserve for Encumbrances
1,500,000
Revenues
680,000
Encumbrances
1,500,000
Construction Expenditures
3,338,000
Other Financing Sources—Proceeds of Bonds
3,800,000
$6,839,000
$6,839,000
Required
a. Prepare the June 30, 2011, statement of revenues, expenditures, and changes in fund balance for the capital projects fund.
b. Has the capital project been completed? Explain your answer.
Construction Fund. During FY 2011, the voters of the Town of Dex approved constructing and equipping a recreation center to be financed by tax supported bonds in the amount of $3,000,000. During 2011, the following events and transactions occurred.
1. Preliminary planning and engineering expenses in the amount of $60,000 were incurred. No money was immediately available for paying these costs (credit Vouchers Payable).
2. A contract was let under competitive bids for a major segment of the construction project in the amount of $2,500,000.
3. An invoice for $1,600,000 was received from a contractor for a portion of work that had been completed under the general contract.
4. The bond issue was sold at par plus accrued interest of $25,000 (the accrued interest was deposited in the fund that will service the bonded debt).
5. The contractor’s bill, less a 4 percent retention, was vouchered for payment.
6. All vouchers payable, except $1,300 (about which there was some controversy), were paid.
7. Fiscal year end closing entries were prepared.
Required
a. Prepare journal entries to record the preceding information in the Town of Dex Recreation Center Construction Fund and the governmental activities general journal at the government wide level.
b. Prepare a Town of Dex Recreation Center Construction Fund balance sheet for the year ended December 31, 2011.
c. Prepare a Recreation Center Construction Fund statement of revenues, expenditures, and changes in fund balance for the year ended December 31, 2011.
d. How would these capital expenditures for the recreation center appear on the Town of Dex’s government wide statements of net assets and activities?
Capital Project Transactions. In 2011, Falts City began work to improve certain streets to be financed by a bond issue and supplemented by a federal grant. Estimated total cost of the project was $4,000,000; $2,500,000 was to come from the bond issue, and the balance from the federal grant. The capital projects fund to account for the project was designated as the Street Improvement Fund.
The following transactions occurred in 2011:
1. Issued $100,000 of 6 percent bond anticipation notes to be repaid from the proceeds of bonds in 180 days.
2. The federal grant was recorded as a receivable; half of the grant is to be paid to Flats City in 2011 and the remainder late in 2012. The grantor specifies that the portion to be received in 2012 is not available for use until 2012 because there is no guarantee that the federal government will appropriate the 2012 portion.
3. A contract was let to Appel Construction Company for the major part of the project on a bid of $2,700,000.
4. An invoice received from the city’s Stores and Services Fund for supplies provided to the Street Improvement Fund in the amount of $60,000 was approved for payment. (This amount had not been encumbered.)
5. Preliminary planning and engineering costs of $69,000 were paid to the Mid Atlantic Engineering Company. (This cost had not been encumbered.)
6. A voucher payable was recorded for an $18,500 billing from the local telephone company for the cost of moving some of its underground properties necessitated by the street project.
7. An invoice in the amount of $1,000,000 was received from Appel for progress to date on the project. The invoice was consistent with the terms of the contract, and a liability was recorded in the amount of $1,000,000.
8. Cash received during 2011 was as follows:
From federal government
$ 750,000
From sale of bonds at par
2,500,000
9. The bond anticipation notes and interest thereon were repaid (see Transaction
1). Interest is an expenditure of the capital projects fund and, per GASB standards, will not be capitalized as part of the cost of street improvements.
10. The amount billed by the contractor (see Transaction 7) less 5 percent retainage was paid.
11. Temporary investments were purchased at a cost of $1,800,000.
12. Closing entries were prepared as of December 31, 2011.
Required
a. Prepare journal entries to record the preceding information in the general ledger accounts for the Street Improvement Fund. (You may ignore the entries that would also be required in the governmental activities general journal at the government wide level.)
b. Prepare a balance sheet for the Street Improvement Fund as of December 31, 2011.
c. Prepare a statement of revenues, expenditures, and changes in fund balance for the period, assuming that the date of authorization was July 1, 2011.
The debt limit for general obligation debt for Milos City is 1 percent of the assessed property valuation for the city. Using the following information, calculate the city’s debt margin.
Financial Statement Impact of Incurring General Long term Debt on Behalf of Other Governments.
Facts: The Bates County government issued $2.5 million of tax supported bonds to finance a major addition to the Bates County Hospital, a legally separate organization reported as a discretely presented component unit of the county. At the end of the fiscal year in which the debt was issued and the project completed, the county commission was shocked to see a deficit of more than $2 million reported for unrestricted net assets in the Governmental Activities column of the government wide statement of net assets, compared with a surplus of over $400,000 the preceding year. The commission is quite concerned about how creditors and citizens will react to this large deficit and have asked you, in your role as county finance director, to explain how the deficit occurred and what actions should be taken to eliminate it.
Required
a. Write a brief memo to the county commission explaining how the $2.5 million bond issue for the addition to the Bates County Hospital resulted in the large and apparently unexpected deficit in unrestricted net assets.
b. In your memo, explain what actions can be taken, if any, to eliminate the deficit in governmental activities unrestricted net assets, or at least make it less objectionable.
Facts: A county government and a legally separate organization—the Sports Stadium Authority—entered into an agreement under which the authority issued revenue bonds to construct a new stadium. Although the intent is to make debt service payments on the bonds from a surcharge on ticket sales, the county agreed to annually advance the Sports Stadium Authority the required amounts to make up any debt service shortfalls and has done so for several years. Accordingly, the county has recorded a receivable from the authority and the authority has recorded a liability to the county for all advances made under the agreement. Ticket surcharge revenues that exceed $1,500,000 are to be paid to the county and to be applied first toward interest and then toward principal repayment of advances.
Both parties acknowledge, however, that annual ticket surcharge revenues may never exceed $1,500,000, since to reach that level would require an annual paid attendance of 3,000,000. Considering that season ticket holders and luxury suite renters are not included in the attendance count, it is quite uncertain if the required trigger level will ever be reached. The authority has twice proposed to raise the ticket surcharge amount, but the county in both cases vetoed the proposal. Thus, the lender in this transaction (the county) has imposed limits that appear to make it infeasible for the borrower (the authority) to repay the advances. Consequently, the authority’s legal counsel has taken the position that the authority is essentially a pass through agency with respect to the advances in that the authority merely receives the advances and passes them on to a fiscal agent for debt service payments. Moreover, they note that the bonds could never have been issued in the first place without the county’s irrevocable guarantee of repayment, since all parties knew from the beginning that the authority likely would not have the resources to make full debt service payments. Based on the foregoing considerations, the authority’s legal counsel has rendered an opinion that the liability for the advances can be removed from the authority’s accounts. The county tacitly agrees that the loans (advances) are worthless, since it records an allowance for doubtful loans equal to the total amount of the advances. Still, the county board of commissioners refuses to remove the receivable from its accounts because of its ongoing rights under the original agreement for repayment.
Required
a. Assume you are the independent auditor for the authority, and provide a written analysis of the facts of this case, indicating whether or not you concur with the authority’s decision to no longer report the liability to the county for debt service advances.
b. Alternatively, assume you are the independent auditor for the county and, based on the same analysis you conducted for requirement a, indicate whether or not you concur with the county continuing to report a receivable for debt service advances on its General Fund balance sheet and government wide statement of net assets.
Assessing General Obligation Debt Burden. This case focuses on the analysis of a city’s general obligation debt burden. After examining the accompanying table that shows a city’s general obligation (tax supported) debt for the last ten fiscal years, answer the following questions.
Required
a. What is your initial assessment of the trend of the city’s general obligation debt burden?
b. Complete the table by calculating the ratio of Net General Bonded Debt to Assessed Value of taxable property and the ratio of Net General Bonded Debt per Capita. In addition, you learn that the average ratio of Net General Bonded Debt to Assessed Value for comparable size cities in 2011 was 2.13 percent, and the average net general bonded debt per capita was $1,256. Based on time series analysis of the ratios you have calculated and the benchmark information provided in this paragraph, is your assessment of the city’s general obligation still the same as it was in part a, or has it changed? Explain.
Ratio of Net General Bonded Debt to Assessed Value and Net Bonded Debt per Capita
Examine the CAFR. Utilizing the comprehensive annual financial report (CAFR) obtained for Exercise 1–1, follow the instructions below.
a. General Long term Liabilities.
(1) Disclosure of Long term Debt. Does the report contain evidence that the government has general long term liabilities? What evidence is there? Does the report specify that no such debt is outstanding, or does it include a list of outstanding tax supported debt issues; capital lease obligations; claims, judgments, and compensated absence payments to be made in future years; and unfunded pension obligations? Refer to the enterprise funds statement of net assets as well as note disclosures for long term liabilities. Are any enterprise debt issues backed by the full faith and credit of the general government? If so, how are the primary liability and the contingent liability disclosed?
(2) Changes in Long term Liabilities. How are changes in long term liabilities during the year disclosed? Is there a disclosure schedule for long term liabilities similar to Illustration 6–1? Does the information in that schedule agree with the statements presented for capital projects funds and debt service funds and the government wide financial statements?
Are interest payments and principal payments due in future years disclosed? If so, does the report relate these future payments with resources to be made available under existing debt service laws and covenants?
(3) Debt Limitations. Does the report contain information as to legal debt limit and legal debt margin? If so, is the information contained in the report explained in enough detail so that an intelligent reader (you) can understand how the limit is set, what debt is subject to it, and how much debt the government might legally issue in the year following the date of the report?
(4) Overlapping Debt. Does the report disclose direct debt and overlapping debt of the reporting entity? What disclosures of debt of the primary government are made in distinction to debt of component units? Is debt of component units reported as “direct” debt of the reporting entity or as “overlapping debt”?
b. Debt Service Funds.
(1) Debt Service Function. How is the debt service function for tax supported debt and special assessment debt handled—by the General Fund, by a special revenue fund, or by one or more debt service funds? If there is more than one debt service fund, what kinds of bond issues or other debt instruments are serviced by each fund? Is debt service for bonds to be retired from enterprise revenues reported by enterprise funds? Does the report state the basis of accounting used for debt service funds? If so, is the financial statement presentation consistent with the stated basis? If the basis of accounting is not stated, analyze the statements to determine which basis is used—full accrual, modified accrual, or cash basis. Is the basis used consistent with the standards discussed in this chapter?
(2) Investment Activity. Compare the net assets reserved for debt service, if any, in the Governmental Activities column of the government wide statement of net assets and the fund balance of each debt service fund at balance sheet date with the amount of interest and the amount of debt principal the fund will be required to pay early in the following year (you may find debt service requirements in the notes to the financial statements or in supplementary schedules following the individual fund statements in the Financial Section of the CAFR). If debt service funds have accumulated assets in excess of amounts needed within a few days after the end of the fiscal year, are the excess assets invested? Does the CAFR contain a schedule or list of investments of debt service funds? Does the report disclose increases or decreases in the fair value of investments realized during the year? Does the report is close net earnings on investments during the year? What percentage of revenue of each debt service fund is derived from earnings on investments? What percentage of the revenue of each debt service fund is derived from taxes levied directly for the debt service fund? What percentage is derived from transfers from other funds? List any other sources of debt service revenue and other financing sources, and indicate the relative importance of each source. Are estimated revenues for term bond debt service budgeted on an actuarial basis? If so, are revenues received as required by the actuarial computations?
(3) Management. Considering the debt maturity dates as well as the amount of debt and apparent quality of debt service fund investments, does the debt service activity appear to be properly managed? Does the report disclose whether investments are managed by a corporate fiduciary, another outside investment manager, or governmental employees? If outside investment managers are employed, is the basis of their fees disclosed? Are the fees accounted for as additions to the cost of investments or as expenditures? Is one or more paying agents, or fiscal agents, employed? If so, does the report disclose whether the agents keep track of the ownership of registered bonds, write checks to bondholders for interest payments and matured bonds or, in the case of coupon bonds, pay matured coupons and matured bonds presented through banking channels? If agents are employed, does the balance sheet or the notes to the financial statements disclose the amount of cash in their possession? If so, does this amount appear reasonable in relation to interest payable and matured bonds payable? Do the statements, schedules, or narratives disclose for how long a period of time debt service funds carry a liability for un presented checks for interest on registered bonds, for matured but un presented interest coupons, and for matured but un presented bonds?
(4) Capital Lease Rental Payments. If general capital assets are being acquired under capital lease agreements, are periodic lease rental payments accounted for as expenditures of a debt service fund (or by another governmental fund)? If so, does the report disclose that the provisions of SFAS No. 13 are being followed (see the “Use of Debt Service Funds to Record Capital Lease Payments” section of this chapter) to determine the portion of each capital lease payment considered as interest and the portion considered as payment on the principal.
Three identical units of Item QBM are purchased during February, as shown below.
Item QBM
Units
Cost
Feb. 8
Purchase
1
$ 45
15
Purchase
1
48
26
Purchase
1
51
Total
3
$144
Average cost per unit
$ 48 ($144/3 units)
Assume that one unit is sold on February 27 for $70. Determine the gross profit for February and ending inventory on February 28 using the (a) first in, first out (FIFO); (b) last in, first out (LIFO); and (c) average cost methods.
Beginning inventory, purchases, and sales for Item ER27 are as follows:
Nov. 1
Inventory
40 units at $5
5
Sale
32 units
11
Purchase
60 units at $7
21
Sale
45 units
Assuming a perpetual inventory system and using the first in, first out (FIFO) method, determine (a) the cost of merchandise sold on November 21 and (b) the inventory on November 30.
Beginning inventory, purchases, and sales for Item ER27 are as follows:
Nov. 1
Inventory
40 units at $5 s
5
Sale
32 unit
11
Purchase
60 units at $7
21
Sale
45 units
Assuming a perpetual inventory system and using the last in, first out (LIFO) method, determine (a) the cost of the merchandise sold on November 21 and (b) the inventory on November 30.
The units of an item available for sale during the year were as follows:
Jan.
1
Inventory
6 units at $50
$ 300
Mar. 20
Purchase
14 units at $55
770
Oct. 30
Purchase
20 units at $62
1,240
Available for sale
40 units
$2,310
There are 16 units of the item in the physical inventory at December 31. The periodic inventory system is used. Determine the inventory cost using (a) the first in, first out (FIFO) method, (b) the last in, first out (LIFO) method, and (c) the average cost method.
On the basis of the following data, determine the value of the inventory at the lower of cost or market. Apply lower of cost or market to each inventory item as shown in Exhibit 7.
Stewart Co.’s beginning inventory and purchases during the year ended December 31, 2008, were as follows:
Unit
Total
Units
Cost
Cost
January 1
Inventory
1,000
$50.00
$ 50,000
March 10
Purchase
1,200
52.50
63,000
June 25
Sold 800 units
August 30
Purchase
800
55.00
44,000
October 5
Sold 1,500 units
November 26
Purchase
2,000
56.00
112,000
December 31
Sold 1,000 units
Total
5,000
$269,000
Instructions
1. Determine the cost of inventory on December 31, 2008, using the perpetual inventory system and each of the following inventory costing methods:
a. first in, first out
b. last in, first out
2. Determine the cost of inventory on December 31, 2008, using the periodic inventory system and each of the following inventory costing methods:
a. first in, first out
b. last in, first out
c. average cost
3. Assume that during the fiscal year ended December 31, 2008, sales were $290,000 and the estimated gross profit rate was 40%. Estimate the ending inventory at December 31, 2008, using the gross profit method.
Matching. Place the abbreviations corresponding to the appropriate reporting attribute(s) in the spaces provided for each financial statement. Include all that apply.
Activities or Funds
Basis of Accounting
Governmental activities—GA
Accrual—A
Business type activities—BTA
Modified accrual—MA
Governmental funds—GF
Proprietary funds—PF
Measurement Focus
Fiduciary funds—FF
Economic resources—ER
Current financial resources—CFR
Financial Statements
Activities or Funds Reported
Basis of Accounting
Measurement Focus
Statement of net assets—government wide
Statement of activities— government wide
Balance sheet— governmental funds
Statement of revenues, expenditures, and changes in fund balances—governmental funds
Statement of net assets— proprietary funds
Statement of revenues, expenses, and changes in fund net assets— proprietary funds
Policy Issues Relating to Property Taxes. Property owners in Trevor City were shocked when they recently received notice that assessed valuations on their homes had increased by an average 35 percent, based on a triennial reassessment by the County Board of Equalization. Like many homeowners in the city, you have often complained about the high property taxes in Trevor City, and now you are outraged that your taxes will apparently increase another 35 percent in the coming year. After stewing all weekend about the unreasonable increase in assessed valuation, you decide to visit the county tax assessor on Monday to find out why your assessed valuation has increased so rapidly. When you finally reach the counter, the customer service representative explains that reassessment considers such factors as actual property sales in particular neighborhoods, trends in building costs, and home improvements. He also explains that heavy demand for both new and previously owned homes has skyrocketed in the Trevor City area in recent years. Moreover, you learn that the reassessment on your home is only average, with some being higher and some lower. Although this information calms you down somewhat, you ask: “But how can we possibly afford a 35 percent increase in our taxes next year?” The representative explains that actual tax rates are set by each jurisdiction having taxing authority over particular properties (in your case, these are the county government, Trevor City, the Trevor City Independent School District, the Trevor City Library, and the Trevor City Redevelopment Authority), so he cannot say how much property taxes will actually increase.
Required
a. When you have regained your composure, prepare a brief written analysis objectively evaluating the probability that your property taxes will actually increase by 35 percent next year. In doing so, consider factors that you feel may militate against such a large increase. What would have to happen to the tax rates for your taxes to remain at their current level or increase only slightly?
b. Put yourself in the position of the city manager of Trevor City. Does she view the rapid growth in property values as a windfall for the city? What are the potential economic and political risks involved with a hot real estate market such as Trevor City is experiencing?
Reporting Internal Service Fund Financial Information at the Government wide Level. During the current fiscal year, the City of Manchester created a Printing and Sign Fund (an internal service fund) to provide custom printing and signage for city departments, predominantly those financed by the General Fund. As this is the city’s first internal service fund, finance officials are uncertain how to account for the activities of the Printing and Sign Fund at the government wide level. After much discussion, they have approached you, the audit manager, with the following questions:
1. In governmental activities at the government wide level, should expenses for printing and signage within the various functions be the amount billed to departments or the Printing and Sign Fund’s cost to provide the printing and signage service? Please explain.
2. What about the Printing and Sign Fund’s operating revenues from billings to departments? Should these revenues be reported as program revenues, specifically, as charges for services of the functions receiving the services? Why or why not?
3. The Printing and Sign Fund obtains about 10 percent of its revenues from the City Electric, Sewage, and Water Fund, an enterprise fund. Should the financial information related to these transactions be reported in the Business type Activities column of the government wide financial statements, rather than the Governmental Activities column? Please explain in detail.
Required
a. Evaluate these questions and provide the city’s finance director with a written response to each question.
b. How would your response to question 3 differ if the Printing and Sign Fund provided 60 percent of its total services to the enterprise fund?
Reporting Multipurpose Grant Transactions in the Funds and Government wide Financial Statements of Local Government Recipients. In this case, local governments receive reimbursements from the state government’s Department of Social Services Teen Assistance Program for expenditures incurred in conducting an array of locally administered programs that benefit troubled teens. The state program provides reimbursement up to a maximum amount based on grant applications submitted annually by each local government and provides notification of the amounts approved prior to the grant year. Each local government determines which kinds of teen programs and what mix of services are most appropriate for its community. Reimbursements are made only after services have been provided and documented claims for reimbursements have been submitted to the state. GASB standards relevant to this grant state: Multipurpose grants (those that provide financing from more than one program) should be reported as program revenue if the amounts restricted to each program are specifically identified in the grant award or grant agreement. Multipurpose grants that do not provide for specific identification of the programs and amounts should be reported as general revenues.
Required
a. In which fiscal year(s) should the grant be reported on the fund and government wide financial statements of the local governments receiving the grant reimbursements? Please explain your answer.
b. How should the grant be reported on the fund and government wide financial statements? Please explain your answer.
Examine the CAFR. Utilizing the comprehensive annual financial report obtained for Exercise 1–1, follow these instructions.
a. Governmental Activities, Government wide Level. Answer the following questions. (1) Are governmental activities reported in a separate column from business type activities in the two government wide financial statements? (2) Are assets and liabilities reported either in the relative order of their liquidity or on a classified basis on the statement of net assets? (3) Is information on expenses for governmental activities presented at least at the functional level of detail? (4) Are program revenues segregated into (a) charges for services, (b) operating grants and contributions, and (c) capital grants and contributions on the statement of activities?
b. General Fund. Answer the following questions. (1) What statements and schedules pertaining to the General Fund are presented? (2) In what respects (headings, arrangements, items included, etc.) do they seem similar to the year end statements illustrated or described in the text? (3) In what respects do they differ? (4) What purpose is each statement and schedule intended to serve? (5) How well, in your reasoned opinion, does each statement and schedule accomplish its intended purpose? (6) Are any noncurrent or non liquid assets included in the General Fund balance sheet? If so, are they offset by “Reserve” accounts in the Fund Equity section? (7) Are any noncurrent liabilities included in the General Fund balance sheet? If so, describe them. (8) Are revenue classifications sufficiently detailed to be meaningful? (9) Has the government refrained from reporting expenses rather than expenditures?
c. Special Revenue Funds. Answer the following questions. (1) What statements and schedules pertaining to the special revenue funds are presented? (2) Are these only combining statements, or are there also statements for individual special revenue funds? (3) Are expenditures classified by character (i.e., current, intergovernmental, capital outlay, and debt service)? (4) Are current expenditures further categorized at least by function?
d. Examine Again. Refer to part b. Answer each question again, now from the perspective of the special revenue funds. Review your answers to Exercises 1–1, 2–1, and 3–1 in light of your study of Chapter 4. If you now believe your earlier answers were not entirely correct, change them to conform with your present understanding of GASB financial reporting standards.
Calculating Required Tax Anticipation Financing and Recording Issuance of Tax Anticipation Notes. The City of Perrin collects its annual property taxes late in its fiscal year. Consequently, each year it must finance part of its operating budget using tax anticipation notes. The notes are repaid upon collection of property taxes. On April 1, 2011, the City estimated that it will require $2,470,000 to finance governmental activities for the remainder of the 2011 fiscal year. On that date, it had $740,000 of cash on hand and $830,000 of current liabilities. Collections for the remainder of FY 2011 from revenues other than current property taxes and from delinquent property taxes, including interest and penalties, were estimated at $1,100,000.
Required
a. Calculate the estimated amount of tax anticipation financing that will be required for the remainder of FY 2011. Show work in good form.
b. Assume that on April 2, 2011, the City of Perrin borrowed the amount calculated in part a by signing tax anticipation notes bearing 5 percent per annum to a local bank. Record the issuance of the tax anticipation notes in the general journals of the General Fund and governmental activities at the government wide level.
c. By October 1, 2011, the City had collected a sufficient amount of current property taxes to repay the tax anticipation notes with interest. Record the repayment of the tax anticipation notes and interest in the general journals of the General Fund and governmental activities at the government wide level.
Property Tax Calculations and Journal Entries. The Village of Darby’s budget calls for property tax revenues for the fiscal year ending December 31, 2011, of $2,660,000. Village records indicate that, on average, 2 percent of taxes levied are not collected. The county tax assessor has assessed the value of taxable property located in the village at $135,714,300.
Required
a. Calculate to the nearest penny what tax rate per $100 of assessed valuation is required to generate a tax levy that will produce the required amount of revenue for the year.
b. Record the tax levy for 2011 in the General Fund. (Ignore subsidiary detail and entries at the government wide level.)
c. By December 31, 2011, $2,540,000 of the current property tax levy had been collected. Record the amounts collected and reclassify the uncollected amount as delinquent. Interest and penalties of 6 percent were immediately due on the delinquent taxes, but the finance director estimates that 10 percent will not be collectible. Record the interest and penalties receivable. (Round all amounts to the nearest dollar.)
Adjusting Entries for Inventory of Supplies. The Village of Baxter uses the purchases method of accounting for its inventories of supplies in the General Fund. GASB standards, however, require that the consumption method be used for the government wide financial statements. Because its computer system is very limited, the Village uses a periodic inventory system, adjusting inventory balances based on a physical inventory of supplies at year end. When supplies are received during the year, the Village records expenditures and expenses in the general journals of the General Fund and governmental activities, respectively. The Village’s inventory records showed the following information for the fiscal year ending December 31, 2011:
Balance of inventory, December 31, 2010
$140,000
Purchases of inventory during 2011
720,000
Balance of inventory, December 31, 2011
155,000
Required
a. Provide the required adjusting entries at the end of 2011, assuming that the December 31, 2011, balance of Inventory of Supplies has been confirmed by physical count. Make entries in the general journals of both the General Fund (omitting subsidiary detail) and governmental activities at the government wide level.
b. Assume that the General Fund uses the consumption method for reporting inventories of supplies rather than the purchases method. Make the required adjusting entries for the General Fund and governmental activities at the government wide level.
Special Revenue Fund, Voluntary Non exchange Transactions. The City of Eldon applied for a competitive grant from the state government for park improvements such as upgrading hiking trails and bike paths. On May 1, 2011, the City was notified that it had been awarded a grant of $200,000 for the program, to be received in two installments on July 1, 2011, and July 1, 2012. The grant stipulates that $100,000 is for use in each of the city’s fiscal years ending June 30, 2012, and June 30, 2013. Any amounts not expended during FY 2012 can be carried over for use in FY 2013. During FY 2012, the city expended $90,000 for park improvements from grant resources.
Required
For the special revenue fund, provide the appropriate journal entries, if any, that would be made for the following:
1. May 1, 2011, notification of grant approval.
2. July 1, 2011, receipt of first installment of the grant.
3. During FY 2011 to record expenditures under the grant.
Closing Journal Entries. At the end of a fiscal year, budgetary and operating statement control accounts in the general ledger of the General Fund of Dade City had the following balances: Appropriations, $6,224,000; Estimated Other Financing Uses, $2,776,000; Estimated Revenues, $7,997,000; Encumbrances, $0; Expenditures, $6,192,000; Other Financing Uses, $2,770,000; and Revenues, $7,980,000. Appropriations included the authorization to order a certain item at
a cost not to exceed $65,000; this was not ordered during the year because it will not be available until late in the following year.
Required
Show in general journal form the entry needed to close all of the preceding accounts that should be closed as of the end of the fiscal year.
Interfund and Interactivity Transactions. The following transactions affected various funds and activities of the City of Atwater.
1. The Fire Department, a governmental activity, purchased $100,000 of water from the Water Utility Fund, a business type activity.
2. The Municipal Golf Course, an enterprise fund, reimbursed the General Fund $1,000 for office supplies that the General Fund had purchased on its behalf and that were used in the course of the fiscal year.
3. The General Fund made a long term loan in the amount of $50,000 to the Central Stores Fund, an internal service fund that services city departments.
4. The General Fund paid its annual contribution of $80,000 to the debt service fund for interest and principal on general obligation bonds due during the year.
5. The $5,000 balance in the capital projects fund at the completion of construction of a new City Hall was transferred to the General Fund.
Required
a. Make the required journal entries in the general journal of the General Fund and any other fund(s) affected by the inter fund transactions described. Also make entries in the governmental activities journal for any transaction(s) affecting a governmental fund. Do not make entries in the subsidiary ledgers.
b. Why is it unnecessary to make entries in a business type activities journal for any transaction(s) affecting proprietary funds? Are internal service funds any different?
Transactions and Budgetary Comparison Schedule. The following transactions occurred during the 2011 fiscal year for the City of Fayette. For budgetary purposes, the city reports encumbrances in the Expenditures section of its budgetary comparison schedule for the General Fund but exclude expenditures
chargeable to a prior year’s appropriation.
1. The budget prepared for the fiscal year 2011 was as follows:
Estimated Revenues:
Taxes
$1,943,000
Licenses and permits
372,000
Intergovernmental revenue
397,000
Miscellaneous revenues
62,000
Total estimated revenues
2,774,000
Appropriations:
General government
471,000
Public safety
886,000
Public works
650,000
Health and welfare
600,000
Miscellaneous appropriations
86,000
Total appropriations
2,693,000
Budgeted increase in fund balance
$ 81,000
2. Encumbrances issued against the appropriations during the year were as follows:
General government
$ 58,000
Public safety
250,000
Public works
392,000
Health and welfare
160,000
Miscellaneous appropriations
71,000
Total
$931,000
3. The current year’s tax levy of $2,005,000 was recorded; un collectibles were estimated as $65,000.
4. Tax collections from prior years’ levies totaled $132,000; collections of the current year’s levy totaled $1,459,000.
5. Personnel costs during the year were charged to the following appropriations in the amounts indicated. Encumbrances were not recorded for personnel costs. Since no liabilities currently exist for withholdings, you may ignore any FICA or federal or state income tax withholdings. (Note: Expenditures charged to Miscellaneous Appropriations should be treated as General Government expenses in the governmental activities general journal at the government wide level.)
General government
$ 411,000
Public safety
635,000
Public works
254,000
Health and welfare
439,000
Miscellaneous appropriations
11,100
Credit to Vouchers Payable
$1,750,100
6. Invoices for all items ordered during the prior year were received and approved for payment in the amount of $14,470. Encumbrances had been recorded in the prior year for these items in the amount of $14,000. The amount chargeable to each year’s appropriations should be charged to the Public Safety appropriation.
7. Invoices were received and approved for payment for items ordered in documents recorded as encumbrances in Transaction (2) of this problem. The following appropriations were affected.
Actual Liability
Estimated Liability
General government
$ 52,700
$ 52,200
Public safety
236,200
240,900
Public works
360,000
357,000
Health and safety
130,600
130,100
Miscellaneous appropriations
71,000
71,000
$850,500
$851,200
8. Revenue other than taxes collected during the year consisted of licenses and permits, $373,000; intergovernmental revenue, $400,000; and $66,000 of miscellaneous revenues. For purposes of accounting for these revenues at the government wide level, the intergovernmental revenues were operating grants and contributions for the Public Safety function. Miscellaneous revenues are not identifiable with any function and therefore are recorded as General Revenues at the government wide level.
9. Payments on Vouchers Payable totaled $2,505,000. Additional information follows: The General Fund Fund Balance account had a credit balance of $82,900 as of December 31, 2010; no entries have been made in the Fund Balance account during 2011.
Required
a. Record the preceding transactions in general journal form for fiscal year 2011 in both the General Fund and governmental activities general journals.
b. Prepare a budgetary comparison schedule for the General Fund of the City of Fayette for the fiscal year ending December 31, 2011, as shown in Illustration
Do not prepare a government wide statement of activities since other governmental funds would affect that statement.
4–10 Operating Transactions, Special Topics, and Financial Statements. The City of Ashland’s General Fund had the following post closing trial balance at April
30, 2010, the end of its fiscal year:
Debits
Credit
Cash
$ 97,000
Taxes Receivable—Delinquent
583,000
Estimated Uncollectible Delinquent Taxes
$189,000
Interest and Penalties Receivable
26,280
Estimated Uncollectible Interest and Penalties
11,160
Inventory of Supplies
16,100
Vouchers Payable
148,500
Due to Federal Government
59,490
Reserve for Inventory of Supplies
16,100
Fund Balance
298,130
$722,380
$722,380
During the year ended April 30, 2011, the following transactions, in summary form, with subsidiary ledger detail omitted, occurred:
1. The budget for FY 2011 provided for General Fund estimated revenues totaling $3,140,000 and appropriations totaling $3,100,000.
2. The city council authorized temporary borrowing of $300,000 in the form of a 120 day tax anticipation note. The loan was obtained from a local bank at a discount of 6 percent per annum (debit Expenditures for discount).
3. The property tax levy for FY 2011 was recorded. Net assessed valuation of taxable property for the year was $43,000,000, and the tax rate was $5 per $100. It was estimated that 4 percent of the levy would be uncollectible.
4. Purchase orders and contracts were issued to vendors and others in the amount of $2,059,000.
5. The County Board of Review discovered unassessed properties with a total taxable value of $500,000. The owners of these properties were charged with taxes at the city’s General Fund rate of $5 per $100 assessed value.
(You need not adjust the Estimated Uncollectible Current Taxes account.)
6. $1,961,000 of current taxes, $383,270 of delinquent taxes, and $20,570 of
interest and penalties were collected.
7. Additional interest and penalties on delinquent taxes were accrued in the amount of $38,430, of which 30 percent was estimated to be uncollectible.
8. Because of a change in state law, the city was notified that it will receive $80,000 less in intergovernmental revenues than was budgeted.
9. Total payroll during the year was $819,490. Of that amount, $62,690 was withheld for employees’ FICA tax liability, $103,710 for employees’ federal income tax liability, and $34,400 for state taxes; the balance was paid to employees in cash.
10. The employer’s FICA tax liability was recorded for $62,690.
11. Revenues from sources other than taxes were collected in the amount of $946,700.
12. Amounts due the federal government as of April 30, 2011, and amounts due for FICA taxes, and state and federal withholding taxes during the year were vouchered.
13. Purchase orders and contracts encumbered in the amount of $1,988,040 were filled at a net cost of $1,987,570, which was vouchered.14. Vouchers payable totaling $2,301,660 were paid after deducting a credit for purchases discount of $8,030 (credit Expenditures).
15. The tax anticipation note of $300,000 was repaid.16. All unpaid current year’s property taxes became delinquent. The balances of the current tax receivables and related un collectibles were transferred to delinquent accounts.
17. A physical inventory of materials and supplies at April 30, 2011, showed a total of $19,100. Inventory is recorded using the purchases method in the General Fund; the consumption method is used at the government wide level.
Required
a. Record in general journal form the effect of the above transactions on the General Fund and governmental activities for the year ended April 30, 2011. Do not record subsidiary ledger debits and credits.
b. Record in general journal form entries to close the budgetary and operating statement accounts.
c. Prepare a General Fund balance sheet as of April 30, 2011.
d. Prepare a statement of revenues, expenditures, and changes in fund balance for the year ended April 30, 2011. Do not prepare the government wide financial statements.
Permanent Fund and Related Special Revenue Fund Transactions. Annabelle Benton, great granddaughter of the founder of the Town of Benton, made a cash contribution in the amount of $500,000 to be held as an endowment. To account for this endowment, the town has created the Alex Benton Park Endowment Fund. Under terms of the agreement, the town must invest and conserve the principal amount of the contribution in perpetuity. Earnings, measured on the accrual basis, must be used to maintain Alex Benton Park in an “attractive manner.” All changes in fair value are treated as adjustments of fund balance of the permanent fund and do not affect earnings. Earnings are transferred periodically to the Alex Benton Park Maintenance Fund, a special revenue fund. Information pertaining to transactions of the endowment and special revenue funds for the fiscal year ended June 30, 2011, follows:
1. The contribution of $500,000 was received and recorded on December 31, 2010.
2. On December 31, 2010, bonds having a face value of $400,000 were purchased for $406,300, plus three months of accrued interest of $6,000. A certificate of deposit with a face and fair value of $70,000 was also purchased on this date. The bonds mature on October 1, 2019 (105 months from date of purchase), and pay interest of 6 percent per annum semiannually on April 1 and October 1. The certificate of deposit pays interest of 4 percent per annum payable on March 31, June 30, September 30, and December 31.
3. On January 2, 2011, the town council approved a budget for the Alex Benton Park Maintenance Fund, which included estimated revenues of $13,400 and appropriations of $13,000.
4. On March 31, 2011, interest on the certificate of deposit was received by the endowment fund and transferred to the Alex Benton Park Maintenance Fund.
5. The April 1, 2011, bond interest was received by the endowment fund and transferred to the Alex Benton Park Maintenance Fund.
6. On June 30, 2011, interest on the certificate of deposit was received and transferred to the Alex Benton Park Maintenance Fund.
7. For the year ended June 30, 2011, maintenance expenditures from the Alex Benton Park Maintenance Fund amounted to $2,700 for materials and contractual services and $10,150 for wages and salaries. All expenditures were paid in cash except for $430 of vouchers payable as of June 30, 2011. Inventories of materials and supplies are deemed immaterial in amount.
8. On June 30, 2011, bonds with face value of $100,000 were sold for $102,000 plus accrued interest of $1,500. On the same date, 2,000 shares of ABC Corporation’s stock were purchased at $52 per share.
Required
a. Prepare in general journal form the entries required in the Alex Benton Park Endowment Fund to record the transactions occurring during the fiscal year ending June 30, 2011, including all appropriate adjusting and closing entries. (Note: Ignore related entries in the governmental activities journal at the government wide level.)
b. Prepare in general journal form the entries required in the Alex Benton Park Maintenance Fund to record Transactions 1–8.
c. Prepare the following financial statements:
(1) A balance sheet for both the Alex Benton Park Endowment Fund and the Alex Benton Park Maintenance Fund as of June 30, 2011.
(2) A statement of revenues, expenditures, and changes in fund balance for both the Alex Benton Park Endowment Fund and the Alex Benton Park Maintenance Fund for the year ended June 30, 2011.
Using the Modified Approach or Depreciation. You are an auditor in a regional public accounting firm that does a large volume of governmental audits and consulting engagements. A large metropolitan city has asked you for assistance in determining whether it should use the modified approach or depreciate its infrastructure assets. The city is particularly interested in which accounting approach other large metropolitan cities have chosen.
Required
a. Examine several comprehensive annual financial reports (CAFRs) of large cities prepared following GASBS 34. (Note: The GASB provides a list of GASBS 34 implementers classified by type of government with links to the governments’ CAFRs, if available, at its Web site, www.gasb.org.) Create a table that lists the cities and the methods they have chosen to report their general infrastructure assets.
b. Prepare a memo to your client summarizing the results of your research. Be sure to address the city’s specific concern about what other large cities are doing with respect to reporting of infrastructure assets.
c. Your client has heard that the Government Finance Officers Association (GFOA) may still award a Certificate of Achievement for Excellence in Financial Reporting if a government decides that the costs of capitalizing and depreciating (or of using the modified approach for) infrastructure assets outweighs the benefits, assuming that all other criteria are met. What other consequences can you point out to your client if it decides not to capitalize and report infrastructure assets.
Options for Financing Public Infrastructure. Desert City is a rapidly growing city in the Southwest, with a current population of 200,000. To cope with the growing vehicular traffic and the need for infrastructure expansion (e.g., streets, sidewalks, lighting, storm water drains, and sewage systems) to stay abreast of the pace of residential and commercial development, members of the city council have recently engaged in debate about the merits of alternative mechanisms for financing infrastructure expansion. The two alternatives the council is exploring are: (1) a sales tax referendum to increase an existing one half cent capital improvement tax by one quarter cent on every dollar of sales, and (2) a development fee of $0.50 per square foot imposed on real estate developers for new residential and commercial buildings. Public debate at recent city council meetings has been contentious, with developers arguing that the burden for infrastructure improvements would be disproportionately placed on homeowners and businesses, whereas reliance on a sales tax increase would permit part of the infrastructure burden to be borne by nonresidents who shop in and otherwise enjoy the benefits of Desert City. Developers have also argued that more of the existing one half cent capital improvement tax should be spent for street and sidewalk improvements and less should be spent for improvement of public buildings, parks, and hiking trails. Proponents of the proposed real estate development fee argue that new residential and commercial building is the main factor driving the growing demand for infrastructure development. Thus, they argue, it is most appropriate that new residents and new businesses shoulder much of the burden for expanding infrastructure. They further argue that the development fee will result in only a modest, largely invisible increase in the cost of each new building. Moreover, the incremental cost of the development fee should be recaptured as property values increase as a result of enhanced infrastructure. Finally, they argue that Desert City citizens enjoy better health and a generally higher quality life as a result of park and hiking trail improvements and that the existing one half cent sales tax should continue to support recreational facilities.
Required
a. Evaluate the advantages and disadvantages of each potential financing option from the viewpoint of (1) a city council member, (2) the city manager, (3) current homeowners and business owners, and (4) potential new homeowners or new business owners.
b. Would accounting for infrastructure construction be impacted by the choice of financing method? Yes or No? Explain.
Recording and Reporting of Damaged Capital Assets. Recent river flooding damaged a part of the Town of Brownville Library. The library building is over 70 years old and is located in a part of the town that is on the national historic preservation register. Some of the costs related to the damage included the following:
1. The building wiring had to be replaced. Since the wiring was over 20 years old, replacing the wiring allowed the town to bring the wiring up to current code and accommodate the increasing technology needs of the library.
2. A large section of the interior walls (dry wall) of the library had to be replaced and painted. The same type of material was used in replacing the interior walls.
3. All hardwood floors were replaced with the same materials.
4. Over 30,000 books suffered water damage.
Required
a. Discuss whether the fact that the library building is in the historic part of town has any role in determining how to record and report the damage and repairs to the library.
b. Discuss how to determine if the library should be considered impaired and, if it is impaired, how accounting and reporting should be handled.
c. Discuss whether you would classify the costs incurred to repair the building as enhancements or replacements.
d. What information would you want before determining how to record and report the damage to the books?
Examine the CAFR. Utilizing the CAFR obtained for Exercise 1–1, answer these questions.
a. General and Other Capital Assets:
(1) Reporting of Capital Assets. Are capital assets reported as a line item in the government wide statement of net assets? Are non depreciable capital assets reported on a separate line from depreciable capital assets, or are they separately reported in the notes to the financial statements? Do the notes include capital asset disclosures, such as those for the City and County of Denver shown in Illustration 5–2? Does the disclosure show beginning balances, increases and decreases, and ending balances for each major class of capital assets, as well as the same information for accumulated depreciation for each major class? Are these disclosures presented separately for the capital assets of governmental activities, Business type activities, and discretely presented component units? Do the notes specify capitalization thresholds for all capital assets, including infrastructure? Do the notes show the amounts of depreciation expense assigned to each major function or program for governmental activities at the government wide level? Are the depreciation policies and estimated lives of major classes of depreciable assets disclosed? Do the notes include the entity’s policies regarding capitalization of collections of works of art and historical treasures? Are accounting policies disclosed for assets acquired under capital leases?
(2) Other. Is the accumulated cost of construction work in progress recorded as an asset anywhere? In your opinion, is the information disclosed about construction work in progress and construction commitments adequate? Which fund, or funds, account for cash received, or receivables created, from sales of general capital assets? Are the proceeds of sales of general capital assets reported as another financing source or as revenue?
b. Capital Projects Funds:
(1) Title and Content. What title is given to the funds that function as capital projects funds, as described in this chapter? (Street Improvement Funds and Capital Improvement Funds are common titles, although these titles also are often used for special revenue funds that account for ongoing annual maintenance of roadways.) Where does the report state the basis of accounting used for capital projects funds? Is the basis used consistent with GASB standards discussed in this chapter? Are there separate capital projects funds for each project, are there several funds, each of which accounts for related projects, or is only one fund used for all projects?
(2) Statements and Schedules. What statements and schedules pertaining to capital projects funds are presented? In what respects (headings, arrangement, items included, etc.) do they seem similar to statements illustrated or described in the text? In what respects do they differ? Are any differences merely a matter of terminology or arrangement, or do they represent significant deviations from GASB accounting and reporting standards for capital projects funds?
(3) Financial Resource Inflows. What is the nature of the financial resource inflows utilized by the capital projects funds? If tax supported bonds or special assessment bonds are the source, have any been sold at a premium? At a discount? If so, what was the accounting treatment of the bond premium or discount?
(4) Fund Expenditures. How much detail is given concerning capital projects fund expenditures? Is the detail sufficient to meet the information needs of administrators? Legislators? Creditors? Grantors? Interested residents? For projects that are incomplete at the date of the financial statement, does the report compare the percentage of total authorization for each project expended to date with the percentage of completion? For those projects completed during the fiscal year, does the report compare the total expenditures for each project with the authorization for each project? For each cost overrun, how was the overrun financed?
(5) Assets Acquired under Capital Leases. Were any general capital assets acquired by the primary government or one or more component units under a capital lease agreement during the year for which you have statements? If so, was the present value of minimum lease rentals recorded as an Expenditure and as an Other Financing Source in a capital projects fund (or in any other governmental fund)? If the primary government or one or more component units leased assets from another component unit, how are the assets, related liabilities, expenditures, and other financing sources reported in the basic financial statements or in another section of the CAFR of the reporting entity?
Four new desktop computers, for which the cost exceeded the city’s capitalization threshold, were purchased for use in the city clerk’s office using General Fund resources. Which of the following entries would be required to completely record this transaction?
Machinery and equipment depreciation expense for general capital assets totaled $163,000 for the reporting period. Which of the following correctly defines the recording of depreciation for general capital assets?
c. Depreciation is allocated, and recorded at the government wide level with
a debit to the functions or programs of government and a credit to accumulated depreciation.
d. Since depreciation does not involve the use of financial resources it is not necessary for the government to record it at the fund level or government wide level.
The following information was collected from the most recent Income Statement and comparative Balance Sheet of Dolor Corporation:
Increase in cash
$36,000
Decrease in accounts receivable
$17,000
Increase in merchandise inventory
$44,000
Decrease in prepaid rent
$3,000
Increase in equipment
$56,000
Increase in accumulated depreciation
$18,000
Decrease in accounts payable
$25,000
Increase in salaries payable
$2,000
Increase in interest payable
$1,000
Decrease in deferred income taxes
$4,000
Increase in notes payable
$12,000
Dolor”s net income for the year was $167,000. No direct exchange transactions occurred at Dolor during the year. No equipment was sold during the year. Cash dividends of $30,000 were declared and paid during the year. Dolor uses the indirect method to prepare its statement of cash flows.
Required:
Prepare Dolor”s operating activities section of its statement of cash flows.
Comparative balance sheets and the income statements for Ellis Company are presented below:
Ellis Company
Balance Sheets
December 31, Year 1 and Year 2
Year 2
Year 1
Assets
Current assets:
Cash
$ 45,000
$ 30,000
Accounts receivable
38,000
40,000
Inventory
67,000
60,000
Total current assets
150,000
130,000
Long term investments.
162,000
200,000
Plant and equipment
278,000
150,000
Accumulated depreciation
(52,000)
(50,000)
Total assets
$538,000
$430,000
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable
$ 36,000
$ 40,000
Accrued liabilities
24,000
30,000
Total current liabilities
60,000
70,000
Bonds payable
20,000
30,000
Mortgage payable
100,000
Deferred income taxes
15,000
20,000
Total liabilities
195,000
120,000
Stockholders’ equity:
Common stock.
295,000
270,000
Retained earnings
48,000
40,000
Total stockholders’ equity
343,000
310,000
Total liabilities and stockholders’ equity
$538,000
$430,000
Ellis Company
Income Statement
For the Year Ended December 31, Year 2
Sales
$150,000
Less cost of goods sold
76,500
Gross margin
73,500
Less operating expenses
16,000
Net operating income
57,500
Less loss on sale of investment
2,500
Income before taxes
55,000
Less income taxes
22,000
Net income
$ 33,000
Summary of transactions for Year2:
* During Year 2, the company sold for cash of $35,500 long term investments with a cost of $38,000 when purchased.
* All sales were on credit.
* The company paid a cash dividend of $25,000.
* Bonds payable of $25,000 were retired by issuing common stock. The bonds retired were equivalent to the market value of the $25,000 stock issued.
* An addition to one of the company’s buildings was completed on December 31,Year 2, at a cost of $128,000. The company gave an interest bearing mortgage for$100,000 and paid $28,000 in cash.
* Bonds payable were sold for $15,000 cash at par value.
Required:
a. Using the indirect method, determine the net cash provided by operating activitiesfor Year 2.
b. Using the direct method, determine the net cash provided by operating activitiesfor Year 2.
c. Using the net cash provided by operating activities figure from either part a or b, prepare a statement of cash flows for Year 2.
Hesselbaum Retail Corporation”s most recent Income Statement and comparative Balance Sheet is as follows:
Hesselbaum Retail Corporation
Income Statement
For the Year Ended December 31, Year 2
Sales
$118,000
Less cost of goods sold
56,000
Gross margin
62,000
37,000
Net operating income
25,000
Less loss on sale of equipment
2,000
Income before taxes
23,000
Less income taxes
9,000
Net income
$ 14,000
Hesselbaum Retail Corporation
Comparative Balance Sheet
At December 31, Year 2, and Year 1
Year 2
Year 1
Assets
Cash
$12,000
$ 4,000
Accounts receivable, net
29,000
7,000
Merchandise inventory
36,000
21,000
Prepaid expenses
6,000
8,000
Equipment
72,000
88,000
Accumulated depreciation
(60,000)
(57,000)
Total assets
$95,000
$71,000
Liabilities and stockholders’ equity
Accounts payable
$17,000
$ 9,000
Wages payable
6,000
1,000
Taxes payable
2,000
3,000
Common stock
50,000
42,000
Retained earnings
20,000
16,000
Total liabilities and stockholders’ equity
$95,000
$71,000
No direct exchange transactions occurred at Hesselbaum during Year 2. No equipment was purchased during Year 2. The accumulated depreciation on the equipment soldwas $9,000. Cash dividends of $10,000 were declared and paid during Year 2. Hesselbaum uses the direct method to prepare its statement of cash flows.
Required:
Prepare Hesselbaum”s operating activities section of its Year 2 statement of cash flows.
The following information is taken from the Operating Activities section of the statement of cash flows for the Parks Company for the year just ended:
Net income
$15,000
Adjustments to convert net income to cash basis:
Accounts receivable
$ 3,000
Gain on sale of equipment
(3,000)
Inventory
(7,000)
Accounts payable
4,000
Depreciation expense
11,000
Interest payable
(1,000)
Prepaid expenses
2,000
Income tax payable
(7,000)
2,000
Net cash inflow from operating activities
$17,000
The following information is taken from the company’s income statement for the year just ended:
Sales
$96,000
Cost of goods sold
42,000
Gross margin
54,000
Operating Expenses
29,000
Net operating income
25,000
Gain on sale of equipment
3,000
Income before taxes
28,000
Income taxes
13,000
Net income
$15,000
Required:
a. For each of the adjustments to convert net income to the cash basis, indicate whether the account increased or decreased.
b. Determine the net cash provided by operating activities using the direct method. You need not prepare the formal operating activities section of the statement of cash flows but you should show the adjustments that must be made to sales, expenses, and so forth and the cash flow balances of sales, expenses, etc.
1. Identify and explain the characteristics that distinguish governmental and not for profit entities from for profit entities.
2. Identify the authoritative bodies responsible for setting financial reporting standards for (1) state and local governments, (2) the federal government, and (3) not for profit organizations.
3. Contrast and compare the objectives of financial reporting for (1) state and local governments, (2) the federal government, and (3) not for profit organizations.
4. Explain the minimum requirements for general purpose external financial reporting for state and local governments and how they relate to comprehensive annual financial reports.
5. Explain the different objectives, measurement focus, and basis of accounting of the government wide financial statements and fund financial statements of state and local governments.
Research Case—Governmental or Not for Profit Entity? In partnership with Jefferson County and the Mound City Visitor’s Bureau, Mound City recently established a Native American Heritage Center and Museum, organized as a tax exempt not for profit organization. Although the facility does not charge admission, signs at the information desk in the entry lobby encourage gifts of $3.00 for adults and $1.00 for children, 12 and under. Many visitors make the recommended contribution, some contribute larger amounts, and some do not contribute at all. Such contributions comprise 40 percent of the museum’s total annual revenues, with net proceeds from fund raising events and governmental grants comprising the remaining 60 percent. The center operates from a city owned building for which it pays a nominal $1 per year in rent. Except for a full time executive director and a part time assistant, the center is staffed by unpaid volunteers. The center is governed by a seven member board of directors, each appointed for a three year term. Four of the directors are appointed by the Mound City Council, two by the Jefferson County Commission, and one by the Mound City Visitor’s Bureau. Should the center cease to operate, its charter provides that 60 percent of its net assets will revert to the city, 25 percent to the county, and 15 percent to the Visitor’s Bureau. At the end of its first year of operation, the board of directors decided to engage a local CPA to conduct an audit of the center’s financial statements. The board expects to receive an unqualified (clean) audit opinion stating that its financial statements are presented fairly in conformity with generally accepted accounting principles.
Required
Assume you are the CPA who has been engaged to conduct this audit. To which standards setting body (or bodies) would you look for accounting and financial reporting standards to assist you in determining whether the center’s financial statements are in conformity with generally accepted accounting principles? Explain how you arrived at this conclusion.
Examine the CAFR. Download a copy of the most recent comprehensive annual financial report (CAFR) for the City and County of Denver from its or that of another city or county if you wish.∗?Familiarize yourself with the organization by scanning the report and reread the section in this chapter entitled “Financial Reporting of State and Local Governments.” Be prepared to discuss in class the items suggested below.
a. Introductory Section.
Read the letter of transmittal or any narrative that accompanies the financial statements. Does this material define the governmental reporting entity and name the primary government and all related component units included in the report? (Note: The reporting entity may be discussed in the notes to the financial statements rather than in the transmittal letter.) Does the introductory section discuss the financial condition of the reporting entity at the balance sheet date? Does it discuss the most significant changes in financial condition that occurred during the year? Does it alert the reader to forthcoming changes in financial condition that are not as yet reflected in the financial statements? Do the amounts reported in the letter of transmittal or other narrative agrees with amounts in the statements and schedules in the financial section? Does the introductory section include a list of principal officials? An organization chart? A reproduction of a Certificate of Achievement for Excellence in Financial Reporting from the Government Finance Officers Association (GFOA)? Assuming the government follows GASBS 34, compare the information in the letter of transmittal with that in the management discussion & analysis (MD&A).
b. Financial Section.
(1) Audit Report. Are the financial statements in the report audited by an independent CPA, state auditors, or auditors employed by the government being audited? Does the auditor indicate who is responsible for preparing the financial statements? Does the auditor express an opinion that the statements are “in accordance with generally accepted accounting principles applicable to governmental entities in the United States” or some other phrase? Is the opinion qualified in some manner, disclaimed, or adverse? Does the auditor indicate that the opinion covers the basic financial statements or that plus combining statements?
(2) Basic Financial Statements. Does the CAFR contain the two government wide financial statements and seven fund statements and required reconciliation?
(3) Notes to the Financial Statements. How many notes follow the required basic financial statements? Is there a phrase at the bottom of the basic financial statements indicating that the notes are an integral part of the financial statements?
(4) Individual Fund and Combining Statements. Following the notes to the financial statements, does the CAFR provide combining and individual fund statements? Do these combining statements aggregate all the funds of a given fund type or all the non major funds?
(5) Management’s Discussion and Analysis (MD&A). Does the CAFR contain an MD&A? If so, where is it located and what type of information does it contain?
c. Statistical Tables.
Examine these tables so that you can refer to them in discussions accompanying subsequent chapters. For example, is multiyear information provided about financial trends, revenue capacity, debt capacity, demographic and economic trends, and operating activities?
On December 31, Year 1, Rex Corporation borrowed $100,000 from the Third National Bank of Springfield. Rex has five years to pay off the note. On December 31, Year 2, Rex paid$9,000 of interest on the loan and paid off $20,000 of the loan. Rex uses the direct method to prepare its statement of cash flows.
1 What effect will Rex”s loan have on each section of its Year 1 statement of cash flows?
Operating Activities
Investing Activities
Financing Activities
A)
no effect
$100,000 decrease
$100,000 increase
B)
$100,000 increase
no effect
no effect
C)
no effect
$100,000 increase
no effect
D)
no effect
no effect
$100,000 increase
2 What effect will Rex”s interest and loan payments have on each section of its Year 2
Narley Dude Corporation had net sales of $720,000 and cost of goods sold of $385,000 for the just completed year. Shown below are the beginning and ending balances for the year of various Narley Dude accounts:
Ending
Beginning
Cash..
$34,000
$20,000
Accounts receivable
$49,000
$19,000
Inventory
$67,000
$44,000
Accounts payable
$15,000
$21,000
Narley Dude prepares its statement of cash flows using the direct method.
1 On its statement of cash flows, what amount should Narley Dude show for its net sales adjusted to a cash basis (i.e., cash received from sales)?
A) $690,000
B) $704,000
C) $750,000
D) $755,000
2 On its statement of cash flows, what amount should Narley Dude show for its cost of goods sold adjusted to a cash basis (i.e., cash paid to suppliers)?
The comparative balance sheets for Rayco, Inc., are presented below:
Ending
Beginning
Cash
$ 20,000
$ 15,000
Accounts receivable (net)
27,000
25,000
Inventory
32,000
35,000
Prepaid expenses
8,000
5,000
Long term investments
36,000
38,000
Plant and equipment
108,000
92,000
Accumulated depreciation
(49,000)
(30,000)
Total assets
$182,000
$180,000
Accounts payable
$ 30,000
$ 38,000
Notes payable
40,000
32,000
Deferred income taxes
17,000
35,000
Common stock
45,000
40,000
Retained earnings
50,000
35,000
Total liabilities and stock holders equity
$182,000
$180,000
Rayco, Inc., reported the following net income for the year:
Sales
$200,000
Less cost of goods sold
100,000
Gross margin
100,000
Less operating expenses
52,000
Net operating income
48,000
Gain on sale of investments
2,000
Income before taxes
50,000
Less income taxes
20,000
Net income
$ 30,000
There were no sales or retirements of plant and equipment during the year. Dividends paid to shareholders totaled $15,000. The company uses the direct method for determining the net cash provided by operating activities on its statement of cash flows.
1 Using the direct method, sales adjusted to the cash basis would be:
A) $202,000
B) $198,000
C) $200,000
D) $210,000
2. Using the direct method, cost of goods sold adjusted to the cash basis would be:
A) $95,000
B) $100,000
C) $105,000
D) $108,000
3. The income tax expense adjusted to the cash basis would be:
A) $18,000
B) $2,000
C) $20,000
D) $38,000
4. The net cash provided by operating activities would be:
A) $37,000
B) $39,000
C) $30,000
D) $19,000
5. The net cash provided by financing activities would be:
A) $(2,000)
B) $(10,000)
C) $(15,000)
D) $5,000
6. The net cash provided by investing activities would be:
The changes in Tempski Company”s balance sheet account balances for last year appear below:
Increases
(Decreases)
Debit balances:
Cash
$(5,000)
Accounts receivable
$(7,000)
Inventory
$14,000
Prepaid expenses
$(8,000)
Long term investments
$70,000
Plant and equipment
$35,000
Credit balances:
Accumulated depreciation
$64,000
Accounts payable
$12,000
Accrued liabilities
$(10,000)
Taxes payable
$9,000
Bonds payable
$(30,000)
Deferred taxes
$(10,000)
Common stock
$20,000
Retained earnings
$44,000
The company’s income statement for the year appears below:
Sales
$870,000
Less cost of goods sold
360,000
Gross margin
510,000
Less operating expenses
350,000
Net operating income
160,000
Less income taxes
48,000
Net income
$112,000
The company declared and paid $68,000 in cash dividends during the year. The company uses the direct method to determine the net cash provided by operating activities.
1. On the statement of cash flows, the sales revenue adjusted to a cash basis would be:
A) $877,000
B) $870,000
C) $863,000
D) $891,000
2. On the statement of cash flows, the cost of goods sold adjusted to a cash basis would be:
A) $358,000
B) $348,000
C) $362,000
D) $360,000
3. On the statement of cash flows, the operating expenses adjusted to a cash basis would be:
A) $288,000
B) $350,000
C) $412,000
D) $352,000
4. On the statement of cash flows, the income tax expense adjusted to a cash basis would be:
Alegre Retail Corporation”s most recent comparative Balance Sheet is as follows:
Ending
Beginning
Assets
Cash
$ 7,000
$ 12,000
Accounts receivable, net
11,000
2,000
Merchandise inventory
39,000
24,000
Long term investments
23,000
9,000
Equipment
83,000
100,000
Accumulated depreciation
(66,000)
(62,000)
Total assets
$97,000
$ 85,000
Liabilities and Stockholders’ Equity
Accounts payable
$ 9,000
$28,000
Taxes payable
1,000
2,000
Notes payable
16,000
10,000
Common stock
42,000
30,000
Retained earnings
29,000
15,000
Total liabilities and stockholders’ equity
$97,000
$85,000
Alegre”s net income was $34,000. No direct exchange transactions occurred at Alegre during the year. No equipment was purchased. There was a gain of $3,000 when equipment was sold. The accumulated depreciation on the equipment sold was$12,000. Cash dividends of $20,000 were declared and paid during the year. Alegreuses the indirect method to prepare its statement of cash flows.
Martin Corporation uses the indirect method to prepare its statement of cash flows. If Martin purchases additional equipment, which results in additional depreciation charges, what net effect will the purchase of this additional equipment have on the net cash provided (used) in the following sections of Martin”s statement of cash flows?
Shoshoni Corporation prepares its statement of cash flows using the indirect method. Which of the following would be added to net income in the operating activities section of the statement?
Fawn Corporation prepares its statement of cash flows using the indirect method. Which of the following would be added to net income in the operating activities section of the statement?
Adah Corporation prepares its statement of cash flows using the indirect method. Which of the following would be deducted from net income in the operating activities section of the statement?
Tomlin Corporation prepares its statement of cash flows using the indirect method. Which of the following would be deducted from net income in the operating activities section of the statement?
Wesi Corporation prepares its statement of cash flows using the direct method. Which of the following should Wesi classify as an operating activity on its statement?
Hauta Corporation prepares its statement of cash flows using the indirect method. Which of the following would be deducted from net income in the operating activities section of the statement?
Morgan Company”s net income last year was $73,000 and cash dividends declared and paid to the company”s stockholders totaled $14,000. Changes in selected balance sheet accounts for the year appear below:
Increases
(Decreases)
Debit balances:
Accounts receivable
$10,000
Prepaid expenses
$(3,000)
Credit balances:
Accumulated depreciation
$16,000
Accounts payable
$(4,000)
Bonds payable
$80,000
Based solely on this information, the net cash provided by operations under the indirect method on the statement of cash flows would be:
Mori Company”s net income last year was $25,000 and cash dividends declared and paid to the company”s stockholders totaled $10,000. Changes in selected balance sheet accounts for the year appear below:
Increases
(Decreases)
Debit balances:
Accounts receivable
$(6,000)
Inventory
$2,000
Prepaid expenses
$(1,000)
Long term investments
$20,000
Credit balances:
Accumulated depreciation
$12,000
Accounts payable
$9,000
Taxes payable
$(5,000)
Based solely on this information, the net cash provided by operations under the indirect method on the statement of cash flows would be:
Moretta Company”s net income last year was $32,000 and cash dividends declared and paid to the company”s stockholders totaled $14,000. Changes in selected balance sheet accounts for the year appear below:
Increases
(Decreases)
Debit balances:
Accounts receivable
$7,000
Inventory
$(4,000)
Prepaid expenses
$(1,000)
Long term investments
$8,000
Credit balances:
Accumulated depreciation
$17,000
Accounts payable
$(6,000)
Taxes payable
$7,000
Based solely on this information, the net cash provided by operations under the indirect method on the statement of cash flows would be:
Honalo Corporation had net sales of $515,000 for the just completed year. Shown below are the beginning and ending balances of various Honalo accounts:
Ending
Beginning
Cash
$102,000
$136,000
Accounts receivable
$254,000
$218,000
Inventory
$461,000
$527,000
Accounts payable
$77,000
$96,000
Retained earnings
$367,000
$298,000
Honalo prepares its statement of cash flows using the direct method. On its statementof cash flows, what amount should Honalo show for its net sales adjusted to a cash basis (i.e., cash received from sales)?
The Simplex Company reported cost of goods sold on its income statement of$10,000. The following account balances appeared on the company”s comparative balance sheet for the same year:
Ending
Beginning
Inventory
$22,000
$20,000
Accounts Payable
$14,000
$11,000
The company uses the indirect method to determine the net cash provided by operating activities. The cost of goods sold, adjusted to a cash basis, on the company”s statement of cash flows for the year would be:
Crossland Company reported sales on its income statement of $435,000. On the statement of cash flows, which used the direct method, sales adjusted to a cash basis were $455,000. Crossland Company reported the following account balances on its balance sheet for the year:
Account
Ending
Beginning
Accounts receivable
$30,000
?
Prepaid expenses
$14,000
$11,000
Inventory
$18,000
$20,000
Based on this information, the beginning balance in accounts receivable was:
Duke Company reported cost of goods sold last year of $270,000 on its income statement. Additional information concerning the company”s closing and opening account balances last year follows:
December 31
January 1
Inventory
$60,000
$45,000
Accounts payable
$26,000
$39,000
Duke Company uses the direct method to determine the net cash provided by operating activities on its statement of cash flows. What amount should Duke report as cash paid to suppliers in its statement of cash flows for last year?
Samarium Retail Corporation”s most recent comparative Balance Sheet is as follows:
Assets
Ending
Beginning
Cash
$ 51,000
$ 64,000
Accounts receivable, net
83,000
41,000
Merchandise inventory
96,000
87,000
Equipment
120,000
120,000
Accumulated depreciation
(65,000)
(50,000)
Total assets
$285,000
$262,000
Liabilities and Stockholders’ Equity
Accounts payable
$ 12,000
$ 38,000
Taxes payable
1,000
3,000
Notes payable
30,000
5,000
Common stock
100,000
80,000
Retained earnings
142,000
136,000
Total liabilities and stockholders’ equity
$285,000
$262,000
Samarium”s net income was $46,000. No direct exchange transactions occurred at Samarium during the year. No equipment was sold or purchased. Cash dividends of $40,000 were declared and paid. Samarium uses the indirect method to prepare its statement of cash flows.
1 What is Samarium”s net cash provided (used) by operating activities?
A) $(18,000)
B) $(33,000)
C) $69,000
D) $84,000
2. What is Samarium”s net cash provided (used) by investing activities?
(Cost drivers; ABC; analysis) Shirtz Community Hospital has been under increasing pressure to be accountable for its patient charges. The hospital’s cur rent pricing system is ad hoc, based on pricing norms for the geographical area; only direct costs for surgery, medication, and other treatments are explicitly considered. The hospital’s controller has suggested that the hospital improve pricing policies by seeking a tighter relationship between costs and pricing. This approach would make prices for services less arbitrary. As a first step, the controller has determined that most costs can be assigned to one of three cost pools. The three cost pools follow along with the estimated amounts and activity drivers.
Activity Center
Amount
Activity Driver
Quantity
Professional salaries
$13,125,000
Professional hours
75,000 hours
Building costs
6,187,500
Square feet used
56,250 sq. ft.
Risk management
850,000
Patients served
2,500 patients
The hospital provides service in three broad categories. The services follow with their volume measures for the activity centers.
Professional
Square
Number of
Service
Hours
Feet
Patients
Surgery
3,750
12,500
500
Housing patients
70,000
27,500
1,250
Outpatient care
1,250
16,250
750
a. What bases might be used as cost drivers to allocate the service center costs among the patients served by the hospital l? Defend your selections.
b. The hospital currently charges an “add on” rate calculated using professional hours to patients’ direct charges. What rate is Shirtz Community Hospital charging per hour? (Round to the nearest dollar.)
c. Determine the allocation rates for each activity center cost pool.
d. Allocate the activity center costs to the three services provided by the hospital.
e. Shirtz Community Hospital has decided to estimate costs by activity center using professional hours. What is the cost per professional hour of each activity center? What would cause the cost per hour difference for the three services? (Round to the nearest dollar.)
(ABC; pricing; writing) Balfore Office makes metal five drawer desks and, occasionally, takes custom orders. The company’s overhead costs for a month in which no custom desks are produced are as follows:
Purchasing Department for raw material and supplies (20 purchase orders per month)
$10,000
Setting up machines for production runs (4 times per month after maintenance checks)
2,480
Utilities (based on 6,400 machine hours)
320
Supervisor salaries
16,000
Machine and building depreciation (fixed)
11,000
Quality control and inspections performed on random selection of desks each day; one quality control worker
5,000
Total overhead costs
$44,800
Factory operations are highly automated, and overhead is allocated to products based on machine hours.
In July 2010, six orders were filled for custom desks. Selling prices were based on charges for actual direct material, actual direct labor, and the overhead rate per machine hour. During July, the following costs were incurred for 6,400 hours of machine time:
Purchasing Department for raw material and supplies (44 purchase
$12,400
orders per month)
Setting up machines for production runs (18 times)
3,280
Utilities (based on 6,400 machine hours)
320
Supervisor salaries
16,000
Machine and building depreciation (fixed)
11,000
Quality control and inspections performed on random selection of desks each day; one quality control worker
5,960
Engineering design and specification costs
6,000
Total overhead costs
$54,960
a. How much of the purchasing department cost is variable and how much is fixed? What types of purchasing costs would fit into each of these categories?
b. Why might the number of machine setups have increased from 4 to 18 when only six custom orders were received?
c. Why might the cost of quality control and inspections have increased?
d. Why were engineering design and specification costs included during July?
e. If Balfore Office were to adopt activity based costing, what would you suggest as the cost drivers for each of the overhead cost items?
f. What is the current predetermined overhead rate based on machine hours? Do you think the custom orders should have been priced using this rate per machine hour? Explain the reasoning for your answer.
(ABC) Madolfo Ltd. manufactures two products. Following is a production and cost analysis for each product for 2010:
Cost Component
Product A
Product B
Both Products
Cost
Units produced
10,000
10,000
20,000
Raw material used (units)
X
50,000
50,000
100,000
$800,000
Y
100,000
100,000
$200,000
Labor hours used
Department 1
$682,000
Direct labor
20,000
5,000
25,000
$375,000
Indirect labor
Inspection
2,500
2,400
4,900
Machine operations
5,000
10,000
15,000
Setups
252
248
500
Department 2
$462,000
Direct labor
5,000
5,000
10,000
$200,000
Indirect labor
Inspection
2,680
5,000
7,680
Machine operations
1,000
3,860
4,860
Setups
250
310
560
Machine hours used
Department 1
5,000
10,000
15,000
$400,000
Department 2
5,000
20,000
25,000
$800,000
Power used (kW hours)
$400,000
Department 1
1,500,000
Department 2
8,500,000
Other activity data
Building occupancy
$1,000,000
Purchasing
$100,000
Number of purchase orders
Material X
200
Material Y
300
Square feet occupied
Purchasing
10,000
Power
40,000
Department 1
200,000
Department 2
250,000
Kevin Sharp, the firm’s cost accountant, has just returned from a seminar on activity based costing. To apply the concepts he has learned, he decides to analyze the costs incurred for Products A and B on an activity basis. In doing so, he specifies the following first and second allocation processes:
FIRST STAGE: ALLOCATIONS TO DEPARTMENTS
Cost Pool
Cost Object
Activity Allocation Base
Power
Departments
Kilowatt hours
Purchasing
Material
Number of purchase orders
Building occupancy
Departments
Square feet occupied
SECOND STAGE: ALLOCATIONS TO PRODUCTS
Cost Pool
Cost Object
Activity Allocation Base
Departments Indirect labor
Products
Hours worked
Power
Products
Machine hours
Machinery related
Products
Machine hours
Building occupancy
Products
Machine hours
Material purchasing
Products
Materials used
a. Determine the total overhead for Madolfo Ltd.
b. Determine the plantwide overhead rate for the company, assuming the use of direct labor hours.
c. Determine the cost per unit of Product A and Product B, using the overhead rate found in (b).
d. Determine the cost allocations to departments (first-stage allocations). Allocate costs from the departments in the following order: building occupancy, purchasing, and power. Finish the cost allocations for one department to get an “adjusted” cost to allocate to the next department.
e. Using the allocations found in (d), determine the cost allocations to products(second-stage allocations).
f. Determine the cost per unit of Product A and Product B using the overhead allocations found in (e).
(ABC; pricing) Skagway Co. has identified activity centers to which over head costs are assigned. The cost pool amounts for these centers and their selected activity drivers for 2010 follow.
Activity Centers
Costs
Activity Drivers
Utilities
$1,800,000
90,000 machine hours
Scheduling and setup
1,638,000
1,170 setups
Material handling
3,840,000
2,400,000 pounds of material
The company’s products and other operating statistics follow.
PRODUCTS
A
B
C
Direct costs
$120,000
$120,000
$135,000
Machine hours
45,000
15,000
30,000
Number of setups
195
570
405
Pounds of material
750,000
450,000
1,200,000
Number of units produced
60,000
30,000
90,000
Direct labor hours
48,000
27,000
75,000
a. Determine unit product cost using the appropriate cost drivers for each product.
b. Before it installed an ABC system, the company used a traditional costing sys tem that allocated factory overhead to products using direct labor hours. The firm operates in a competitive market and sets product prices at cost plus a 25 percent markup.
1. Calculate unit costs based on traditional costing. (Round to the nearest cent.)
2. Determine selling prices based on unit costs for traditional costing and for ABC.(Round to the nearest cent.)
c. Discuss the problems related to setting prices based on traditional costing and explain how ABC improves the information.
(ABC; pricing) Perioto Inc. currently charges manufacturing overhead costs to products using machine hours. However, company management believes that the use of ABC would provide more realistic cost estimates and, in turn, give the company an edge in pricing over its competitors. Perioto’s accountant and production manager have pro vided the following budgeted information for 2011, given a budgeted capacity of 1,000,000machine hours:
Type of Manufacturing Cost
Cost Amount
Electric power
$ 500,000
Work cells
3,000,000
Material handling
1,000,000
Quality control inspections
1,000,000
Machine setups
350,000
Total budgeted overhead costs
$5,850,000
Type of Manufacturing Cost
Activity Drivers
Electric power
200,000 kilowatt hours
Work cells
300,000 square feet
Material handling
200,000 material moves
Quality control inspections
50,000 inspections
Machine setups
25,000 setups
A national construction company approached Pete Lang, the VP of marketing, about a bid for 2,500 doors. Lang asked the cost accountant to prepare a cost estimate for producing the 2,500 doors; he received the following data:
Direct material cost
$ 50,000
Direct labor cost
$150,000
Machine hours
5,000
Direct labor hours
2,500
Electric power—kilowatt hours
500
Work cells—square feet
1,000
Number of material handling moves
20
Number of quality control inspections
15
Number of setups
6
a. What is the predetermined overhead rate if the traditional measure of machine hours is used?
b. What is the manufacturing cost per door as presently accounted for?
c. What is the manufacturing cost per door under the proposed ABC method?
d. If the two cost systems will result in different cost estimates, which cost accounting system is preferable as a pricing base and why?
e. If activity based management were implemented prior to an ABC system, which of the manufacturing overhead costs might be reduced or eliminated? Why?
(ABC; decision making) Casito Corp. manufactures multiple types of products; however, most of the company’s sales are from Product #347 and Product #658. Product #347 has been a standard in the industry for several years; the market for this product is competitive and price sensitive. Casito plans to sell 65,000 units of Product #347 in 2011 at a price of $150 per unit. Product #658 is a recent addition to Casito’s product line. This product incorporates the latest technology and can be sold at a premium price; the company expects to sell 40,000 units of this product in 2011 for $300 per unit.
Casito’s management group is meeting to discuss 2011 strategies, and the current topic of conversation is how to spend the sales and promotion budget. The sales man ager believes that the market share for Product #347 could be expanded by concentrating Casito’s promotional efforts in this area. However, the production manager wants to target a larger market share for Product #658. He says, “The cost sheets I get show that the contribution from Product #658 is more than twice that from Product #347.
I know we get a premium price for this product; selling it should help overall profit ability.” Casito has the following costs for the two products:
Product #347
Product #658
Direct material
$80
$140
Direct labor
1.5 hours
4.0 hours
Machine time
0.5 hours
1.5 hours
Variable manufacturing overhead is currently applied on the basis of direct labor hours. For 2011, variable manufacturing overhead is budgeted at $1,120,000 for a total of 280,000 direct labor hours. The hourly rates for machine time and direct labor are $10 and $14, respectively. Casito applies a material handling charge at10 percent of material cost; this material handling charge is not included in variable manufacturing overhead. Total 2011 expenditures for materials are budgeted at$10,800,000.
Marc Alexander, Casito’s controller, believes that before management decides to allocate marketing funds to individual products, it might be worthwhile to look at these products on the basis of the activities involved in their production. Alexander has prepared the following schedule to help the management group understand this concept:
Budgeted
Annual Activity for
Cost
Cost Driver
Cost Driver
Material overhead
Procurement
$ 400,000
Number of parts
4,000,000 parts
Production scheduling
220,000
Number of units
110,000 units
Packaging and shipping
440,000
Number of units
110,000 units
$1,060,000
Variable overhead
Machine setup
$ 446,000
Number of setups
278,750 setups
Hazardous waste disposal
48,000
Pounds of waste
16,000 pounds
Quality control
560,000
Number of inspections
160,000 inspections
General supplies
66,000
Number of units
110,000 units
$1,120,000
Manufacturing
Machine insertion
$1,200,000
Number of parts
3,000,000 parts
Manual insertion
4,000,000
Number of parts
1,000,000 parts
Wave soldering
132,000
Number of units
110,000 units
$5,332,000
REQUIRED PER UNIT
Product #347
Product #658
Parts
25
55
Machine insertions of parts
24
35
Manual insertions of parts
1
20
Machine setups
2
3
Hazardous waste
0.02 lb
0.35 lb
Inspections
1
2
Alexander wants to calculate a new cost, using appropriate cost drivers, for each product. The new cost drivers would replace the direct labor, machine time, and overhead costs in the current costing system.
a. Identify at least four general advantages associated with activity based costing.
b. On the basis of current costs, calculate the total contribution expected in 2011 for
1. Product #347.
2. Product #658.
c. On the basis of activity based costs, calculate the total contribution expected in 2011 for
1. Product #347.
2. Product #658.
d. Explain how the comparison of the results of the two costing methods could impact the decisions made by Casito’s management group.
(ABC; product profitability) West Virginia Concepts provides a wide range of engineering and architectural consulting services through its three offices in Charleston, Morgantown, and Martinsburg. The company allocates resources and bonuses to the three offices based on the net income reported for the period. Following are the performance results for 2010:
Charleston
Morgantown
Martinsburg
Total
Sales
$1,500,000
$1,419,000
$1,067,000
$3,986,000
Less: Direct material
(281,000)
(421,000)
(185,000)
(887,000)
Direct labor
(382,000)
(317,000)
(325,000)
(1,024,000)
Overhead
(725,800)
(602,300)
(617,500)
(1,945,600)
Net income
$ 111,200
$ 78,700
$ (60,500)
$ 129,400
Overhead items are accumulated in one overhead pool and allocated to the offices based on direct labor dollars. For 2010, this predetermined overhead rate was $1.90 for every direct labor dollar incurred. The overhead pool includes rent, depreciation, taxes, etc., regardless of which office incurred the expense. This method of accumulating costs forces the offices to absorb a portion of the overhead incurred by other offices.
Management is concerned with the results of the 2010 performance reports. During a review of overhead costs, it became apparent that many items of overhead are not correlated with direct labor dollars as previously assumed. Management decided that applying overhead based on activity based costing and direct tracing, when possible, should provide a more accurate picture of the profitability of each office. An analysis of the overhead revealed that the following dollars for rent, utilities, depreciation, and taxes could be traced directly to the office that incurred the overhead:
Charleston
Morgantown
Martinsburg
Total
Office overhead
$195,000
$286,100
$203,500
$684,600
Activity pools and activity drivers were determined from the accounting records and staff surveys as follows:
NUMBER OF ACTIVITIES BY LOCATION
Activity Pools
Activity
Charleston
Morgantown
Martinsburg
General administration
$ 409,000
Direct labor
$ 386,346
$ 305,010
$325,344
Project costing
48,000
# of timesheet entries
6,300
4,060
3,640
Accounts payable/receiving
139,000
# of vendor invoices
1,035
874
391
Accounts receivable
47,000
# of client invoices
572
429
99
Payroll/mail sort & delivery
30,000
# of employees
34
39
27
Personnel recruiting
38,000
# of new hires
8
4
8
Employee insur. processing
14,000
# of insur. claims filed
238
273
189
Proposals
139,000
# of proposals
195
245
60
Sales meetings, sales aids
202,000
Contracted sales
$1,821,600
$1,404,150
$569,250
Shipping
24,000
# of projects
100
125
25
Ordering
48,000
# of purchase orders
126
102
72
Duplicating costs
46,000
# of copies duplicated
160,734
145,782
67,284
Blueprinting
77,000
# of blueprints
38,790
31,032
16,378
$1,261,000
a. How much overhead cost should be assigned to each office based on activity based costing concepts? b. What is the contribution of each office before subtracting the results obtained in (a)?
c. What is the profitability of each office using activity based costing?
d. Evaluate the concerns of management regarding the traditional costing technique currently used.
(ABC; pricing) Bernie Lipscomb owns and manages a commercial cold storage warehouse that has 100,000 cubic feet of storage capacity. Historically, he has charged customers a flat rate of $0.16 per pound per month for goods stored.
In the past two years, Lipscomb has become dissatisfied with the profitability of the warehouse operation. Despite the fact that the warehouse remains relatively full, revenues have not kept pace with operating costs. Recently, Lipscomb asked his accountant, Jenna Etheridge, to improve his understanding of how activity based costing could help him revise the pricing formula. Etheridge has determined that most costs can be associated with one of four activities. Those activities and their related costs, volume measures, and volume levels for 2010 follow:
Activity
Cost
Monthly Volume Measure
Send/receive goods
$50,000
Weight in pounds
500,000
Store goods
16,000
Volume in cubic feet
80,000
Move goods
20,000
Volume in square feet
5,000
Identify goods
8,000
Number of packages
500
a. Based on the activity cost and volume data, determine the amount of cost assigned to the following customers, whose goods were all received on the first day of last month:
Weight of Order
Number
Customer
in Pounds
Cubic Feet
Square Feet
of Packages
Barfield
40,000
3,200
1,100
15
Glover
40,000
800
600
10
Dozier
40,000
1,400
1,900
50
b. Determine the price to be charged to each customer under the existing pricing plan.
c. Determine the price to be charged using ABC, assuming Lipscomb would base the price on the cost determined in (a) plus a markup of 40 percent.
d. How well does Lipscomb’s existing pricing plan capture the costs for providing the warehouse services? Explain.
(Activity analysis, ABC; pricing; cost drivers) Moriarity Manufacturing produces two product models: Regular and Special. The following information was taken from the accounting records for the first quarter of 2010:
Regular
Special
Total
Units produced
80,000
20,000
100,000
Material cost
$320,000
$180,000
$500,000
Labor cost
$480,000
$140,000
$620,000
Moriarity currently uses a traditional cost accounting system where total overhead cost is assigned to products based on the total number of units produced. Company president Michael Moriarity has approached the controller, Betsy O’Connell, with concerns about sagging profit margins and his inability to explain competitors’ pricing of similar products. O’Connell suggests that the company explore the possibility of a costing sys tem that is based less on volume and more on identifying the consumption of resources by products (given manufacturing process activities). O’Connell identifies the following overhead costs related to the production process:
Wages and costs related to machine setups
$ 360,000
Material handling costs
480,000
Quality control costs
120,000
Other overhead costs related to units produced
240,000
Total
$1,200,000
During the quarter, there were 40 machine setups for production: 20 from Special to Regular and 20 from Regular to Special. O’Connell believes that the number of set ups is the most appropriate cost driver of machine setup costs. With regard to material handling, the Special model uses more expensive and difficult to handle materials. O’Connell believes that material cost is the primary indicator of material handling costs. Each unit is hand inspected by quality control personnel. Special units require a more time consuming inspection because they are more complex and have more parts than Regular units. Quality control inspectors are paid $40 per hour; examination of payroll time sheets indicates that the inspectors spent 50 percent more hours inspecting Special units than Regular units. O’Connell believes that the remaining 30 percent of overhead costs are related to the number of units produced.
a. Using a traditional, volume based overhead rate, determine the overhead cost per unit of the Regular and Special units.
b. Using the information provided by O’Connell, determine the overhead cost per unit of the Regular and Special Units using an activity based costing system.
c. What is the total per unit cost of the Regular and Special Units under each over head costing system?
d. Compute the amount of product cross subsidization per unit that was taking place under the traditional costing system.
e. Identify potential non value added activities in Moriarity’s current manufacturing system.
f. What suggestions would you have for Michael Moriarity to improve the competitiveness of the company’s products in the marketplace?
(Activity analysis, ABC; pricing; cost drivers; decision making) Hurley Corporation has identified the following overhead costs and cost drivers for the coming year:
Overhead Item
Cost Driver
Budgeted Cost
Budgeted Activity Level
Machine setup
Number of setups
$ 20,000
200
Inspection
Number of inspections
130,000
6,500
Material handling
Number of material moves
80,000
8,000
Engineering
Engineering hours
50,000
1,000
$280,000
The following information was collected on three jobs that were completed during the year:
Job 101
Job 102
Job 103
Direct material
$5,000
$12,000
$8,000
Direct labor
$2,000
$ 2,000
$4,000
Units completed
100
50
200
Number of setups
1
2
4
Number of inspections
20
10
30
Number of material moves
30
10
50
Engineering hours
10
50
10
Budgeted direct labor cost was $100,000, and budgeted direct material cost was $280,000.
a. If the company uses activity based costing, how much overhead cost should be assigned to Job 101?
b. If the company uses activity based costing, compute the cost of each unit of Job 102.
c. The company prices its products at 140 percent of cost. If the company uses activity based costing, what price should it set for each unit of Job 103?
d. If the company used a traditional accounting system and allocated overhead based on direct labor cost, by how much would each unit of Job 103 be over or under costed compared to activity based costing? What would be the management implications of this difference?
e. Identify any non value added activities or activities that may be currently necessary but appear to be inefficient in Hurley’s production process. Explain what steps the company management could take to improve the production process and potentially lower manufacturing costs.
f. The company is considering outsourcing inspections to an outside company that would perform the inspections for $10 apiece. What are the potential total savings if Hurley outsources the inspections? What other factors should company management consider before making this decision?
(ABC; pricing; cost drivers) Believing that its traditional cost system may be providing misleading information, Dover Corporation is considering an activity based costing (ABC) approach. Dover Corporation employs a full cost system and has been applying its manufacturing overhead on the basis of machine hours. The organization plans on using 50,000 direct labor hours and 30,000 machine hours in 2010.The following data show the manufacturing overhead that is budgeted:
Activity
Budgeted Cost Driver
Budgeted Activity Cost
Material handling
Number of parts handled
6,000,000
$ 720,000
Setup costs
Number of setups
750
315,000
Machining costs
Machine hours
30,000
540,000
Quality control
Number of batches
500
225,000
Total manufacturing overhead cost
$1,800,000
Cost, sales and production data for one of the company’s products for the coming year are as follows:
Direct material cost per unit
$4.40
Direct labor cost per unit (.05 DLH @ $15 per DLH)
0.75
Sales and production data:
$5.15
Expected sales
20,000 units
Batch size
5,000 units
Setups
2 per batch
Total parts per finished unit
5 parts
Machine hours required
80 MH per batch
a. Compute the per unit cost for this product for 2010 if Dover Corporation uses the traditional full cost system.
b. Compute the per unit cost for this product for 2010 if the Dover Corporation employs an activity based costing system.
c. Assume the company wishes to achieve a gross profit rate of 40 percent. Determine the selling price that would be required based on your answers to (a) and (b).
(ABC; pricing) Clare’s Super Cake Company makes very elaborate wed ding cakes to order. The company’s owner, Clare Cole, has provided the following data concerning the activity rates in its activity based costing system:
Activity Cost Pools
Activity Rate
Guest related
$0.90 per guest
Tier related
$34.41 per tier
Order related
$150.00 per order
The measure of activity for the size related activity cost pool is the number of planned guests at the wedding reception. The greater the number of guests, the larger the cake. The measure of complexity is the number of cake tiers. The activity measure for the order related cost pool is the number of orders. (Each wedding involves one order.) The activity rates include the costs of raw ingredients such as flour, sugar, eggs, and shortening. The activity rates do not include the costs of purchased decorations such as miniature statues and wedding bells, which are accounted for separately. The average wedding has 125 guests and generally requires a three tiered cake.
Sacks Wedding
Gemmel Wedding
Number of reception guests
50
164
Number of tiers on the cake
1
5
Cost of purchased decorations for cake
$22.50
$58.86
a. What amount would the company have to charge for the Sacks wedding cake to break even on that cake?
b. Assuming that the company charges $650 for the Gemmel wedding cake, what would be the overall gross margin on the order?
c. Letitia White wants to order a special cake for her 25th wedding anniversary celebration. She wants the cake to be four tiers but, in addition, would like 20 special flowers added to the top of the cake, which requires very intricate detailing instead of purchased decorations. White expects that attendance at the anniversary party will be 200 people. If Cole decides to charge $5 for each special flower, which price should she quote? What price should be charged if the company wants to make an overall gross margin of 35 percent on the White order?
d. Suppose that the company decides that the present activity based costing system is too complex and that all costs (except for the costs of purchased decorations) should be allocated on the basis of the number of guests. In that event, what would you expect to happen to the costs of cakes for receptions with more than the average number of guests and for receptions with fewer than the average number of guests? Explain your answer.
(ABC; pricing) Treffle Molding Company manufactures two products: large jar covers and small bottle caps. Large jar covers require special handling. Each cover must be individually sanded on a special machine to remove excess material (referred to as “flash”) from the units. Covers are sanded at the rate of 200 jar covers per hour. Jar covers also require special handling during the packaging process as they are hand packed in special cartons with foam protection to avoid breakage during shipment. Special packaging materials are $5 per carton; each carton holds 250 jar covers.
Small bottle caps are processed in batches of 5,000 units and do not require use of the machine sander. One employee can process a load of small bottle caps in two hours.
The accounting department has established the following information related to overhead cost pools and cost drivers:
Budgeted Annual
Budgeted Activity
Overhead Cost Pool
Overhead Cost
Cost Driver
of Cost Driver
Engineering
$300,000
Engineering hours
3,000 hours
Machine setups
$50,000
Number of setups
100 setups
Material purchase and
$200,000
Number of pounds
2,000,000 pounds
support
of material
Machine sanding
$100,000
Machine hours
10,000 hours
Product certification
$270,000
Number of orders
6,000 orders
Treffle employs 10 direct labor employees. Each employee averages 2,000 hours per year and is paid $25 per hour.
During the month of August, Treffle received an order for 1,000 jar covers from Ravel Cosmetics and an order for 10,000 bottle caps from Nortell Skin Products. Additional information related to each order appears as follows:
Ravel
Nortell
Machine setups
4
1
Raw material ($0.20 per pound)
$200
$500
Engineering hours
10
2
Direct labor hours
4
2
a. Compute the total overhead that should be charged to each order using activity based costing.
b. Compute the total overhead that would be assigned to each order if Treffle uses a single, predetermined overhead rate based on direct labor hours.
c. Compute the full cost per unit under traditional costing and under activity based costing. The company quotes all orders on a cost per 1,000 units basis.
d. Analyze the difference in the cost per order between traditional and ABC. To what factors can the difference be attributed?
e. Based on the costs computed in (c), what selling price per unit would Treffle have to charge for each order to earn a gross profit of 40 percent on the order?
f. The President of Treffle Molding Company, James Mahoney, is upset that the buyer for Ravel Cosmetics insists on small deliveries of each order, resulting in frequent setups to complete each order. How can Mahoney improve this situation?
(Product complexity; writing) Strategic Supply is a world leader in the production of electronic test and measurement instruments. The company experienced almost uninterrupted growth through the 1990s, but in the 2000s, the low priced end of its Portables Division’s product line was challenged by the aggressive low price strategy of several Japanese competitors. These Japanese companies set prices 25 percent below Strategic’s prevailing prices. To compete, the division needed to reduce costs and increase customer value by increasing operational efficiency.
The division took steps to implement just in time delivery and scheduling techniques as well as a total quality control program and to involve people techniques that moved responsibility for problem solving down to the operating level of the division. The results of these changes were impressive: substantial reductions in cycle time, direct labor hours per unit, and inventory levels as well as increases in output dollars per person per day and in operating income. The cost accounting system was providing information, however, that did not seem to support the changes.
Total overhead cost for the division was $10,000,000; of this, 55 percent seemed to be related to materials and 45 percent to conversion. Material related costs pertain to procurement, receiving, inspection, stockroom personnel, and so on. Conversion related costs pertain to direct labor, supervision, and process related engineering. All overhead was applied on the basis of direct labor.
The division decided to concentrate efforts on revamping the application system for material related overhead. Managers believed the majority of material overhead (MOH) costs were related to the maintenance and handling of each different part number. Other types of MOH costs were driven by the value of parts, absolute number of parts, and each use of a different part number.
At this time, the division used 8,000 different parts, each in extremely different quantities. For example, annual usage of one part was 35,000 units; usage of another part was only 200 units. The division decided that MOH costs would decrease if a smaller number of different parts were used in the products.
a. Why would MOH have decreased if parts were standardized?
b. Using the numbers given, develop a cost allocation method for MOH to quantify and communicate the strategy of parts standardization.
c. Explain how the use of the method developed in (b) would support the strategy of parts standardization.
d. Is any method that applies the entire MOH cost pool on the basis of one cost driver sufficiently accurate for complex products? Explain.
e. Are MOH product costing rates developed for management reporting appropriate for inventory valuation for external reporting? Why or why not?
Decision making; writing) Companies that want to be more globally competitive can consider the implementation of activity based management (ABM).Such companies often have used other initiatives that involve higher efficiency, effectiveness, or output quality. These same initiatives are typically consistent with and supportive of ABM.
a. In what other types of “initiatives” might such global companies engage?
b. How might ABM and activity based costing (ABC) help a company in its quest to achieve world class status?
c. For any significant initiative, senior management commitment is generally required. Would it be equally important to have top management support if a company were instituting ABC rather than ABM? Justify your answer.
d. Assume that you are a member of top management in a large organization. Do you think implementation of ABM or ABC would be more valuable? Explain the ratio nale for your answer.
(Decision making; ethics; writing) As the chief executive officer of a large corporation, you have decided after discussion with production and accounting personnel to implement activity based management concepts. Your goal is to reduce cycle time and, in turn, costs. A primary way to accomplish this goal is to install highly automated equipment in your plant, which would then displace approximately 60 per cent of your workforce. Your company is the major employer in the area of the country where it is located.
a. Discuss the pros and cons of installing the equipment from the perspective of your (1) stockholders, (2) employees, and (3) customers.
b. How would you explain to a worker that his or her job is a non value added activity?
c. What alternatives might you have that could accomplish the goal of reducing cycle time but not create economic havoc for the local area?
Axillar Beauty Products Corporation is considering the production of a new conditioning shampoo which will require the purchase of new mixing machinery. The machinery will cost $375,000, is expected to have a useful life of 10 years, and is expected to have a salvage value of $50,000 at the end of 10 years. The machinery will also need a $35,000 overhaul at the end of year 6. A $40,000 increase in working capital will be needed for this investment project. The working capital will be released at the end of the 10 years. The new shampoo is expected to generate net cash inflows of $85,000 per year for each of the 10 years. Axillar”s discount rate is 16%.
Required:
a. What is the net present value of this investment opportunity?
b. Based on your answer to (a) above, should Axillar go ahead with the new conditioning shampoo?
Partida Inc. has provided the following data concerning a proposed investment project:
Initial investment
$861,000
Annual cash receipts
$603,000
Life of the project
5 years
Annual cash expenses
$332,000
Salvage value
$129,000
The company”s tax rate is 30%. For tax purposes, the entire initial investment without any reduction for salvage value will be depreciated over 3 years. The company uses a discount rate of 11%.
1. An increase in long term notes payable is considered to be a financing activity and a source of cash on the statement of cash flows.
2. Under the indirect method of determining the net cash provided by operating activities on the statement of cash flows, an increase in accounts receivable would be deducted from net income to arrive at net cash provided by financing activities.
3. A loss on the sale of an asset would be deducted from net income in computing cash from operating activities under the indirect method on the statement of cash flows.
4. Under the indirect method of determining the net cash provided by operating activities on the statement of cash flows, an increase in accounts payable would be recorded as a deduction from net income.
5. Under the indirect method of determining the net cash provided by operating activities
on the statement of cash flows, an increase in inventory would be added to net income.
6. In computing the net cash provided by operating activities under the indirect method on the statement of cash flows, a decrease in accounts payable would be added to net income.
7. An increase in a prepaid expense would be deducted from net income in computing net cash provided by operating activities on the statement of cash flows under the indirect method.
8. A gain on the sale of equipment would be included as part of a company”s investing activities on the statement of cash flows.
9. Payment of cash dividends to shareholders is considered to be an operating activity on the statement of cash flows.
10. Payment of accrued taxes is considered an operating activity on the statement of cash flows.
11. The sale of preferred stock for cash would be classified as an investing activity in the statement of cash flows.
12. The collection of a long term loan made to a supplier would be treated as an investing activity on a statement of cash flows.
13. Borrowing on a long term note would be considered a financing activity and a source of cash on the statement of cash flows.
14. Under the direct method of determining the net cash provided by operating activities on the statement of cash flows, an increase in inventory would be deducted from cost of goods sold to convert cost of goods sold to a cash basis.
15. Under the direct method of determining the net cash provided by operating activities on the statement of cash flows, a decrease in prepaid expenses would be added to operating expenses to convert operating expenses to a cash basis.
(Absorption vs. variable costing) Tomm’s T’s is a New York–based company that produces and sells t shirts. The firm uses variable costing for internal purposes and absorption costing for external purposes. At year end, financial information must be converted from variable costing to absorption costing to satisfy external requirements.
At the end of 2009, management anticipated that 2010 sales would be 20 percent above 2009 levels. Thus, production for 2010 was increased by 20 percent to meet the expected demand. However, economic conditions in 2010 kept sales at the 2009 unit level of 40,000. The following data pertain to 2009 and 2010:
2009
2010
Selling price per unit
$22
$22
Sales (units)
40,000
40,000
Beginning inventory (units)
4,000
4,000
Production (units)
40,000
48,000
Ending inventory (units)
4,000
?
Per unit production costs (budgeted and actual) for 2009 and 2010 were:
Material
$2.50
Labor
4.00
Overhead
1.75
Total
$8.25
Annual fixed costs for 2009 and 2010 (budgeted and actual) were:
Production
$120,000
Selling and administrative
130,000
Total
$250,000
The predetermined OH rate under absorption costing is based on an annual capacity of 60,000 units. Any volume variance is assigned to Cost of Goods Sold. Taxes are to be ignored.
a. Present the income statement based on variable costing for 2010.
b. Present the income statement based on absorption costing for 2010.
c. Explain the difference, if any, in the income figures. Assuming that there is no Work in Process Inventory, provide the entry necessary to adjust the book income amount to the financial statement income amount if an adjustment is necessary.
d. The company finds it worthwhile to develop its internal financial data on a variable costing basis. What advantages and disadvantages are attributed to variable costing for internal purposes?
e. Many accountants believe that variable costing is appropriate for external reporting; many others oppose its use for external reporting. List the arguments for and against the use of variable costing in external reporting.
Potter Inc. manufactures wizard figurines. All figurines are approximately the same size, but some are plain ceramic whereas others are “fancy,” with purple leather capes and a prism headed wand. Management is considering producing only the fancy figurines because they appear to be substantially more profitable than the ceramic figurines. The company’s total production overhead is $5,017,500. Some additional data follow.
Ceramic
Fancy
Revenues
$15,000,000
$16,800,000
Direct costs
$8,250,000
$8,750,000
Production (units)
1,500,000
350,000
Machine hours
200,000
50, 000
Direct labor hours
34,500
153,625
Number of inspections
1,000
6,500
Required:
a. Potter Inc. has consistently used machine hours to allocate overhead. Determine the profitability of each line of figurines, and decide whether the company should stop producing the ceramic figurines.
b. The cost accountant has determined that production overhead costs can be assigned to separate cost pools. Pool #1 contains $1,260,000 of overhead costs for which the most appropriate cost driver is machine hours; Pool #2 contains $2,257,500 of overhead costs for which the most appropriate cost driver is direct labor hours; and Pool #3 contains $1,500,000 of overhead costs for which the most appropriate cost driver is number of inspections. Compute the overhead cost that should be allocated to each type of figurine using this methodology.
c. Discuss whether the company should continue to manufacture both types of figurines.
What is activity based management (ABM), and what specific management tools are used in ABM?
What is activity analysis, and how is it used with cost driver analysis to manage costs?
Why are value added activities defined from a customer viewpoint?
In a televised football game, what activities are value added? What activities are non value added? Would everyone agree with your choices? Why or why not?
Do cost drivers exist in a traditional accounting system? Are they designated as such? How, if at all, does the use of cost drivers in a traditional accounting system differ from those in an activity based costing system?
If five people from the same organization calculated manufacturing cycle efficiency for one specific process, would each compute the same MCE? Why or why not?
Why do more traditional methods of overhead assignment “overload” standard high volume products with overhead costs. How does ABC improve overhead assignments?
Once an activity based costing system has been developed and implemented in a company, will that system be appropriate for the long term? Why or why not?
Are all companies likely to benefit to an equal extent from adopting ABC? Discuss.
Significant hurdles, including a large time commitment, are often encountered in adopting ABC. What specific activities associated with ABC adoption require large investments of time?
(Activity analysis) The following activities take place in Usher’s Department Store. Upon receipt, Usher’s discounts all products 25 percent from the manufacturer’s suggested retail price. Only after the goods have been in stock for 90 days will additional discounts be given.
1. Attending trade shows to view new products
2. Reviewing supplier catalogs
3. Ordering merchandise
4. Waiting for shipments to be received
5. Inspecting goods for damage
6. Matching receiving reports and purchase orders
7. Placing discounted price tags on merchandise
8. Moving goods to retail area
9. Stocking shelves
10. Training salespersons in store merchandise
11. Checking out customers
12. Handing customer receipts
13. Wrapping gift items
14. Helping customers with return or exchanges
a. Indicate which activities are value added (VA), business value added (BVA), and non value added (NVA).
b. How might some of the business value added activities be reduced or eliminated?
(Activity analysis) The Raleigh plant manager of Allentown Corp. has noticed the plant frequently changes the schedule on its production line. He has gathered the following information on the activities, estimated times, and average costs required for a single schedule change.
Activity
Est. Time
Average Cost
Review impact of orders
30 min.–2 hrs.
$ 300
Reschedule orders
15 min.–24 hrs.
800
Reschedule production orders
15 min.–1 hr.
75
Stop production and change over
10 min.–3 hrs.
150
Return and locate material (excess inventory)
20 min.–6 hrs.
1,500
Generate new production paperwork
15 min.–4 hrs.
500
Change purchasing schedule
10 min.–8 hrs.
2,100
Collect paperwork from the floor
15 min.
75
Review new line schedule
15 min.–30 min.
100
Overtime premiums
3 hrs.–10 hrs.
1,000
Total
$6,600
a. Which of these, if any, are value added activities?
b. What is the cost driver in this situation?
c. How can the cost driver be controlled and the NVA activities eliminated?
(Activity analysis) Farrah Westin plans to build a concrete walkway for her home during her vacation. The following schedule shows how project time will be allocated:
Hours
Purchase materials
5
Obtain rental equipment
2
Remove sod and level site
20
Build forms for concrete
10
Mix and pour concrete into forms
5
Level concrete and smooth
6
Let dry
24
Remove forms from concrete
2
Return rental tools
1
Clean up
4
a. Identify the value added activities. How much of the total is value added time?
b. Identify the non value added activities. How much total time is spent performing non value added activities?
(Value chart) Lin Products manufactures special order office cubicle systems. Production time is two days, but the average cycle time for any order is three weeks. The company president has asked you, as the new controller, to discuss missed delivery dates. Prepare an oral presentation for the executive officers in which you address the following:
a. Possible causes of the problem.
b. How a value chart could be used to address the problem.
(Cost drivers) For each of the following cost pools in a temporary employment agency, identify a cost driver and explain why it is appropriate.
a. Accounts receivable department
b. Payroll department
c. Advertising cost
d. Information technology
e. Utilities
f. Property taxes and insurance on office building
(Levels of costs) Carpenter Inc. designs industrial tooling parts and makes the molds for those parts. The following activities take place when the company creates a new mold. Classify each cost as unit level (U), batch level (B), product/process level (P),or organizational level (O).
a. Consultation with equipment manufacturer on design specifications
b. Engineering design of mold
c. Creating mold
d. Moving materials from warehouse for test quantity
e. Direct materials for test quantity to judge conformity to design specifications
f. Inspecting test quantity
g. Preparing design specification changes based on test molds
h. Depreciating small kiln used solely for test quantities
(Levels of costs) DaSilva Co. has a casting machine that is used for three of the company’s products. Each setup of the machine costs was $18,760 and the casting machine was set up in June for six different production runs. The following information shows the units of output from each of the setups.
Setup #
Product #453
Product #529
Product #663
1
840
2
22,800
3
12,000
4
27,600
5
60
6
17,100
a. If total machine setup cost is allocated to all units of product, what is the setup cost per unit and total setup cost for Products #453, 529, and 663 during June?
b. If machine setup cost is allocated to each type of product made, what is the setup cost per unit of Products #453, 529, and 663 and the total cost of those products during June? (Round to the nearest cent.)
c. If DaSilva Co. had manufactured all similar products in a single production run, how would unit and total costs have changed during June? (Round to the nearest cent.)
(Levels of costs) Three clients (A, B, and C) use Kingsley Call Service’s call center. During October, Kingsley initiated four new equipment advancements. The following information indicates the cost and benefits of each service:
Service Type
Cost
Benefits Client
Estimated Calls Benefitted
Service #359
$ 5,810
A
7,000
Service #360
7,085
A and
2,200
B
4,300
Service #361
3,198
C
1,300
Service #362
4,887
C
2,700
$20,980
17,500
a. If the total cost of new equipment is allocated to all units benefitted, what is the cost per unit and total cost allocated to each client? (Round to the nearest cent.)
b. If the cost of new equipment is allocated to clients benefitted, what is the cost per client and the cost per call benefitted?
c. Assume that Kingsley Call Service charges the costs to the clients as indicated in (b).Client A estimates that a total of 30,000 calls will be processed by Kingsley over the life of the equipment advances. How should Client A allocate the new costs to its callers?
(Levels of costs) Leopold & Olney LLP has 5 partners and 12 staff accountants. The partners each work 2,100 hours per year and earn $350,000 annually. The staffaccountant seach work 2,600 hours per year and earn $80,000 annually. The firm’s total annual budget for professional support available to partners and staff accountants is $312,750. The firm also spends $125,100 for administrative support that is used only by the partners.
a. Assume that total support cost is considered a unit level cost based on number of work hours. What is the support rate per labor hour?
b. If an audit engagement requires 60 partner hours and 220 staff accountant hours, how much professional support cost would be charged to the engagement using the rate determined in (a)?
c. Assume that support costs are considered batch level costs based on number of work hours. What are the support rates per labor hour? (Round to the nearest cent.)
d. If an audit engagement requires 60 partner hours and 220 staff accountant hours, how much support cost would be charged to the engagement using the rates deter mined in (c)?
(OH allocation using cost drivers) Wyeth Corp. has decided to implement anactivity based costing system for its in house legal department. The legal department’s primary expense is professional salaries, which are estimated for associated activities as follows:
Reviewing supplier or customer contracts (Contracts)
Management has determined that the appropriate cost allocation base for Con tracts is the number of pages in the contract reviewed, for Regulation is the number of reviews, and for Court is number of hours of court time. For 2010, the legal department reviewed 450,000 pages of contracts, responded to 750 regulatory review requests, and logged 3,750 hours in court.
a. Determine the allocation rate for each activity in the legal department.
b. What amount would be charged to a producing department that had 21,000 pages of contracts reviewed, made 27 regulatory review requests, and consumed 315 professional hours in court services during the year?
c. How can the developed rates be used for evaluating output relative to cost incurred in the legal department? What alternative does the firm have to maintaining an internal legal department and how might this choice affect costs?
(OH allocation using cost drivers) Regis Place is a health care facility that has been allocating its overhead costs to patients based on number of patient days. The facility’s overhead costs total $3,620,400 per year and the facility (which operates monthly at capacity) has a total of 60 beds available. (Assume a 360 day year.) The facility’s accountant is considering a new overhead allocation method using the following information:
Cost
Cost Driver
Quantity
Rooms (depreciation, cleaning, etc.)
$ 504,000
# of rooms (25 double)
35
Laundry
151,200
# of beds
60
Nursing care
1,314,000
# of nurse hours annually
43,800
Physical therapy
960,000
# of hours of rehab
8,000
General services
691,200
# of patient days
Rooms are cleaned daily; laundry for rooms is done, on average, every other day.
a. How many patient days are available at Regis Place?
b. What is the overhead rate per patient day? (Round to the nearest dollar.)
c. Using the individual cost drivers, what is the overhead rate for each type of cost? (Round to the nearest dollar.)
d. Assume a patient stayed at Regis Place for six days. The patient was in a single room and required 30 hours of physical therapy. What overhead cost would be assigned to this patient under the current method of overhead allocation? What overhead cost would be assigned to this patient under the ABC method of over head allocation?
e. Assume a patient stayed at Regis Place for six days. The patient was in a double room and did not require any physical therapy. What overhead cost would be assigned to this patient under the current method of overhead allocation? What overhead cost would be assigned to this patient under the ABC method of over head allocation?
(ABC) Bernacke Corp. is instituting an activity based costing project in its 10 personpurchasing department. Annual departmental overhead costs are $731,250. Because finding the best supplier takes the majority of effort in the department, most of the costs are allocated to this activity area. Many purchase orders are received in a single shipment.
Activity
Allocation Measure
Quantity
Total Cost
Find best suppliers
Number of telephone calls
375,000
$375,000
Issue purchase orders
Number of purchase orders
46,875
187,500
Review receiving reports
Number of receiving reports
28,125
168,750
One special order product manufactured by the company required the following purchasing department activities: 225 telephone calls, 50 purchase orders, and 25receipts.
a. What amount of purchasing department cost should be assigned to this product?
b. If 100 units of the product are manufactured during the year, what is the purchasing department cost per unit?
c. If purchasing department costs had been allocated using telephone calls as the allocation base, how much cost would have been assigned to this product?
(ABC) Briones Books is concerned about the profitability of its regular dictionaries. Company managers are considering producing only the top quality, hand sewn dictionaries with gold edged pages. Briones is currently assigning the$2,000,000 of overhead costs to both types of dictionaries based on machine hours. Of the overhead, $800,000 is utilities related and the remainder is primarily related to quality control inspectors’ salaries. The following information about the products is also available:
Regular
Hand Sewn
Number produced
2,000,000
1,400,000
Machine hours
170,000
30,000
Inspection hours
10,000
50,000
Revenues
$6,400,000
$5,600,000
Direct costs
$5,000,000
$4,400,000
a. Determine the total overhead cost assigned to each type of dictionary using the cur rent allocation system.
b. Determine the total overhead cost assigned to each type of dictionary if more appropriate cost drivers were used.
c. Should the company stop producing the regular dictionaries? Explain.
(Product profitability) Rice Inc. manufactures lawn mowers and garden tractors. Lawn mowers are relatively simple to produce and are made in large quantities. Garden tractors are customized to individual wholesale customer specifications. The company sells 300,000 lawn mowers and 30,000 garden tractors annually. Revenues and costs incurred for each product are as follows:
Lawn Mowers
Garden Tractors
Revenue
$19,500,000
$17,850,000
Direct material
4,000,000
2,700,000
Direct labor ($20 per hour)
2,800,000
6,000,000
Overhead
?
?
Manufacturing overhead totals $3,960,000, and administrative expenses equal $7,400,000.
a. Calculate the profit (loss) in total and per unit for each product if overhead is assigned to product using a per unit basis.
b. Calculate the profit (loss) in total and per unit for each product if overhead is assigned to products using a direct labor hour basis.
c. Assume that manufacturing overhead can be divided into two cost pools as follows: $1,320,000, which has a cost driver of direct labor hours, and $2,640,000,which has a cost driver of machine hours (totaling 150,000). Lawn mower production uses 25,000 machine hours; garden tractor production uses 125,000 machine hours. Calculate the profit (loss) in total and per unit for each product if overhead is assigned to products using these two overhead bases.
d. Does your answer in (a), (b), or (c) provide the best representation of the profit contributed by each product? Explain.
(Controlling OH; writing) Starshine Company is in the process of analyzing and updating its cost information and pricing practices. Since the company’s product line changed from general paints to specialized marine coatings, there has been tremendous overhead growth, including costs in customer service, production scheduling, inventory control, and laboratory work. Factory overhead has doubled following the shift in product mix. Although some large orders are still received, most current business is generated from products designed and produced in small lot sizes to meet specifically detailed environmental and technical requirements. Management believes that large orders are being penalized and small orders are receiving favorable cost (and, thus, selling price) treatment.
a. Indicate why the shift in product lines would have caused such major increases in overhead.
b. Is it possible that management is correct in its belief about the costs of large and small orders? If so, why?
c.Write a memo to management suggesting how it might change the cost accounting system to reflect the changes in the business.
(Activity analysis) Management at Glover & Lamb Inc. is concerned about controlling factory labor related costs. The following summary is the result of an analysis of the major categories of labor costs for 2010:
Category
Amount
Base wages
$63,000,000
Health care benefits
10,500,000
Payroll taxes
5,018,832
Overtime
8,697,600
Training
1,875,000
Retirement benefits
6,898,500
Workers’ compensation
1,199,940
Following are some of the potential cost drivers identified by the company for labor related costs, along with their 2010 volume levels:
Potential Activity Driver
2010 Volume Level
Average number of factory employees
2,100
Number of new hires
300
Number of regular labor hours worked
3,150,000
Number of overtime hours worked
288,000
Total factory wages paid
$71,697,600
Volume of production in units
12,000,000
Number of production process changes
600
Number of production schedule changes
375
a. For each cost pool, determine the cost per unit of the activity driver using the activity driver that you believe has the closest relationship to the cost pool.
b. Based on your judgments and calculations in (a), which activity driver should receive the most attention from company managers in their efforts to control labor related costs? How much of the total labor related cost is attributable to this activity driver?
c. In the contemporary environment, many firms ask their employees to work record levels of overtime. What activity driver does this practice suggest is a major contributor to labor related costs? Explain.
(Predetermined OH rates; capacity measures) Alberton Electronics makes inexpensive GPS navigation devices and uses a normal cost system that applies over head based on machine hours. The following 2010 budgeted data are available:
Variable factory overhead at 100,000 machine hours
$1,250,000
Variable factory overhead at 150,000 machine hours
1,875,000
Fixed factory overhead at all levels between 10,000 and 180,000 machine hours
1,440,000
Practical capacity is 180,000 machine hours; expected capacity is two thirds of practical.
a. What is Alberton Electronics’ predetermined variable OH rate?
b. What is the predetermined fixed OH rate using practical capacity?
c. What is the predetermined fixed OH rate using expected capacity?
d. During 2010, the firm records 110,000 machine hours and $2,710,000 of overhead costs. How much variable overhead is applied? How much fixed overhead is applied using the rate found in part (b)? How much fixed overhead is applied using the rate found in part (c)? Calculate the total under or overapplied overhead for 2010 using both fixed OH rates.
(High–low method) Information about Indiana Industrial’s utility cost for the last six months of 2010 follows. The high–low method will be used to develop a cost formula to predict 2011 utility charges, and the number of machine hours has been found to be an appropriate cost driver. Data for the first half of 2010 are not being considered because the utility company imposed a significant rate change as of July 1,2010.
Month
Machine Hours
Utility Cost
July
33,750
$13,000
August
34,000
12,200
September
33,150
11,040
October
32,000
11,960
November
31,250
11,500
December
31,000
11,720
a. What is the cost formula for utility expense?
b. What is the budgeted utility cost for September 2011 if 31,250 machine hours are projected?
(High–low method) Wyoming Wholesale has gathered the following data on the number of shipments received and the cost of receiving reports for the first seven weeks of 2010.
Number of Shipments Received
Weekly Cost of Receiving Reports
50
$175
44
162
40
154
35
142
53
185
58
200
60
202
a. Using the high–low method, develop the equation for predicting weekly receiving report costs based on the number of shipments received.
b. What is the predicted amount of receiving report costs for a week in which 72 shipments are received?
c. What are the concerns you have regarding your prediction from part (b)?
(High–low method) La Mia’s Casas builds replicas of residences of famous and infamous people. The company is highly automated, and the new accountant owner has decided to use machine hours as the basis for predicting maintenance costs. The following data are available from the company’s most recent eight months of operations:
Machine Hours
Maintenance Costs
4,000
$1,470
7,000
1,200
3,500
1,680
6,000
1,100
3,000
1,960
9,000
880
8,000
1,020
5,500
1,200
a. Using the high–low method, determine the cost formula for maintenance costs with machine hours as the basis for estimation.
b. What aspect of the estimated equation is bothersome? Provide an explanation for this situation.
c. Within the relevant range, can the formula be reliably used to predict maintenance costs? Can the a and b values in the cost formula be interpreted as fixed and variable costs? Why or why not?
(Flexible budget; variances; cost control) The Sioux City Storage System’s plant prepared the following flexible overhead budget for three levels of activity within the plant’s relevant range.
12,000 units
16,000 units
20,000 units
Variable overhead
$48,000
$64,000
$ 80,000
Fixed overhead
32,000
32,000
32,000
Total overhead
$80,000
$96,000
$112,000
After discussion with the home office, the plant managers planned to produce 16,000units of its single product during 2010. However, demand for the product was exceptionally strong, and actual production for 2010 was 17,600 units. Actual variable and fixed overhead costs incurred in producing the 17,600 units were $69,000 and $32,800,respectively.
The production manager was upset because the company planned to incur $96,000 of costs and actual costs were $101,800. Prepare a memo to the production manager regarding the following questions.
a. Should the $101,800 actual total cost be compared to the $96,000 expected total cost for control purposes? Explain the rationale for your answer.
b. Analyze the costs and explain where the company did well or poorly in controlling its costs.
(Absorption vs. variable costing) Pete’s Plant Stands manufactures wooden stands used by plant nurseries. In May 2010, the company manufactured 18,000 and sold 16,560 stands. The cost per unit for the 18,000 stands produced was as follows:
Direct material
$ 9.00
Direct labor
6.00
Variable overhead
3.00
Fixed overhead
4.00
Total
$22.00
There were no beginning inventories for May and no work in process at the end of May. a. What is the value of ending inventory using absorption costing?
b. What is the value of ending inventory using variable costing?
c. Which accounting method, variable or absorption, would have produced the higher net income for May?
(Production cost; absorption vs. variable costing) Ollie’s Olive Oil began business in 2010, during which it produced 104,000 quarts of olive oil. In 2010, the company sold 100,000 quarts of olive oil. Costs incurred during the year were as follows:
Ingredients used
$228,800
Direct labor
104,000
Variable overhead
197,600
Fixed overhead
98,800
Variable selling expenses
50,000
Fixed selling and administrative expenses
120,000
Total actual costs
$799,200
a. What was the actual production cost per quart under variable costing? Under absorption costing?
b. What was variable cost of goods sold for 2010 under variable costing?
c. What was cost of goods sold for 2010 under absorption costing?
d. What was the value of ending inventory under variable costing? Under absorption costing?
e. How much fixed overhead was charged to expense in 2010 under variable costing? Under absorption costing?
(Variable and absorption costing) Porta Light manufactures a high quality LED flashlight for home/office use. Data pertaining to the company’s 2010 operations are as follows:
Production for the year
45,000 units
Sales for the year (sales price per unit, $8)
48,750 units
Beginning 2010 inventory
8,750 units
Costs to produce one unit (2009 & 2010):
Direct material
$3.60
Direct labor
1.00
Variable overhead
0.60
Fixed overhead
0.40
Selling and administrative costs:
Variable (per unit sold)
$0.40
Fixed (per year)
$150,000
Fixed manufacturing overhead is assigned to units of production based on a predetermined OH rate using an expected production capacity of 100,000 units per year.
a. What is budgeted annual fixed manufacturing overhead?
b. If budgeted fixed overhead equals actual fixed overhead, what is underapplied or overapplied fixed overhead in 2010 under absorption costing? Under variable costing?
c. What is the product cost per unit under absorption costing? Under variable costing?
d. How much total expense is charged against revenues in 2010 under absorption costing? Under variable costing?
e. Is income higher under absorption or variable costing? By what amount?
(Overhead application) Last June, Lacy Dalton had just been appointed CFO of Garland & Wreath when she received some interesting reports about the profitability of the company’s three most important product lines. One of the products, GW1, was produced in a very labor intensive production process; another product, GW7, was produced in a very machine intensive production process; and the third product, GW4, was produced in a manner that was equally labor and machine intensive. Dalton observed that all three products were produced in high volume and were priced to compete with similar products of other manufacturers. Prior to receiving the profit report, Dalton had expected the three products to be roughly equally profitable. However, according to the profit report, GW1 was actually losing a significant amount of money and GW7 was generating an impressively high profit. In the middle, GW4 was producing an average profit. After viewing the profit data, Dalton developed a theory that the “real” profitability of each product was substantially different from the reported profits. To test her theory, Dalton gathered cost data from the firm’s accounting records. Dalton was quickly satisfied that the direct material and direct labor costs were charged to products properly; however, she surmised that the manufacturing overhead allocation was distorting product costs. To further investigate, she gathered the following information:
GW1
GW4
GW7
Monthly direct labor hours
4,000
800
200
Monthly machine hours
800
2,400
12,800
Monthly allocated overhead cost
$80,000
$16,000
$4,000
Dalton noted that the current cost accounting system assigned all overhead to products based on direct labor hours using a predetermined overhead rate.
a. Using the data gathered by Dalton, calculate the predetermined OH rate based on direct labor hours.
b. Find the predetermined OH rate per machine hour that would allocate the current total amount of overhead ($100,000) to the three product lines.
c. Dalton believes the current overhead allocation is distorting the profitability of the product lines; determine the amount of overhead that would be allocated to each product line if machine hours were the basis of overhead allocation.
d. Why are the overhead allocations using direct labor hours and machine hours so different? Which is the better allocation?
(Overhead Application) Sunny Systems manufactures solar panels. The company has a theoretical capacity of 50,000 units annually. Practical capacity is 80 percent of theoretical capacity, and normal capacity is 80 percent of practical capacity. The firm is expecting to produce 30,000 units next year. The company president, Deacon Daniels, has budgeted the following factory overhead costs for the coming year:
Indirect materials: $2.00 per unit
Indirect labor: $144,000 plus $2.50 per unit
Utilities for the plant: $6,000 plus $0.04 per unit
Repairs and maintenance for the plant: $20,000 plus $0.34 per unit
Material handling costs: $16,000 plus $0.12 per unit
Depreciation on plant assets: $210,000 per year
Rent on plant building: $50,000 per year
Insurance on plant building: $12,000 per year
a. Determine the cost formula for total factory overhead in the format of y = a + bX.
b. Determine the total predetermined OH rate for each possible overhead application base.
c. Assume that Sunny Systems produces 35,000 units during the year and that actual costs are exactly as budgeted. Calculate the overapplied or underapplied overhead for each possible overhead allocation base.
(Plant vs. departmental OH rates) Idaho Mechanical Systems has two departments: Fabrication and Finishing. Three workers oversee the 25 machines in Fabrication. Finishing uses 35 crafters to hand polish output, which is then run through buffing machines. Product CG9832 09 uses the following amounts of direct labor and machine time in each department:
Fabrication
Finishing
Machine hours
10.00
0.30
Direct labor hours
0.02
2.00
Following are the budgeted overhead costs and volumes for each department for the upcoming year:
Fabrication
Finishing
Budgeted overhead
$635,340
$324,000
Budgeted machine hours
72,000
9,300
Budgeted direct labor hours
4,800
48,000
a. What is the plantwide OH rate based on machine hours for the upcoming year? How much overhead will be assigned to each unit of Product CG9832 09 using this rate?
b. Idaho Mechanical’s auditors inform management that departmental predetermined OH rates using machine hours in Fabrication and direct labor hours in Finishing would be more appropriate than a plantwide rate. What would the OH rates be for each department? How much overhead would have been assigned to each unit of Product CG9832 09 using departmental rates?
c. Discuss why departmental rates are more appropriate than plantwide rates for Idaho Mechanical.
(Plant vs. departmental OH rates) Red River Farm Machine makes a wide variety of products, all of which must be processed in the Cutting and Assembly departments. For the year 2010, Red River budgeted total overhead of $993,000, of which $385,500 will be incurred in Cutting and the remainder will be incurred in Assembly. Budgeted direct labor and machine hours are as follows:
Cutting
Assembly
Budgeted direct labor hours
27,000
3,000
Budgeted machine hours
2,100
65,800
Two products made by Red River are the RW22SKI and the SD45ROW. The following cost and production time information on these items has been gathered:
RW22SKI
SD45ROW
Direct material
$34.85
$19.57
Direct labor rate in Cutting
$20.00
$20.00
Direct labor rate in Assembly
$ 8.00
$ 8.00
Direct labor hours in Cutting
6.00
4.80
Direct labor hours in Assembly
0.03
0.05
Machine hours in Cutting
0.06
0.15
Machine hours in Assembly
5.90
9.30
a. What is the plantwide predetermined OH rate based on (1) direct labor hours and (2)machine hours for the upcoming year? Round all computations to the nearest cent.
b. What are the departmental predetermined OH rates in Cutting and Assembly using the most appropriate base in each department? Round all computations to the nearest cent.
c. What are the costs of products RW22SKI and SD45ROW using (1) a plantwide rate based on direct labor hours, (2) a plantwide rate based on machine hours, and (3) departmental rates calculated in part (b)?
d. A competitor manufactures a product that is extremely similar to RW22SKI and sells each unit of it for $310. Discuss how Red River’s management might be influenced by the impact of the different product costs calculated in part (c).
(Analyzing mixed costs) Wisconsin Dairy determined that the total predetermined OH rate for costing purposes is $26.80 per cow per day (referred to as an animal day). Of this, $25.20 is the variable portion. Overhead cost information for two levels of activity within the relevant range are as follows:
4,000
6,000
Animal Days
Animal Days
Indirect materials
$25,600
$38,400
Indirect labor
56,000
80,000
Maintenance
10,400
13,600
Utilities
8,000
12,000
All other
15,200
21,600
a. Determine the fixed and variable values for each of the preceding overhead items, and determine the total overhead cost formula.
b. Assume that the total predetermined OH rate is based on expected annual capacity. What is this level of activity for the company?
c. Determine expected overhead costs at the expected annual capacity.
d. If the company raises its expected capacity by 3,000 animal days above the present level, calculate a new total overhead rate for product costing.
(High–low; least squares regression) Green Shade manufactures insulated
windows. The firm’s repair and maintenance (R&M) cost is mixed and varies most directly with machine hours worked. The following data have been gathered from recent operations:
Month
MHs
R&M Cost
May
1,400
$ 9,000
June
1,900
10,719
July
2,000
10,900
August
2,500
13,000
September
2,200
11,578
October
2,700
13,160
November
1,700
9,525
December
2,300
11,670
a. Use the high–low method to estimate a cost formula for repairs and maintenance.
b. Use least squares regression to estimate a cost formula for repairs and maintenance.
c. Does the answer to part (a) or to part (b) provide the better estimate of the relation ship between repairs and maintenance costs and machine hours? Why?
(Flexible budgets) Joe’s Lawn Care Service primarily mows lawns for residential customers. Management has determined direct labor hours is the primary cost driver and has developed the following cost equations based on direct labor hours:
Grooming supplies (variable)
y = $0 + $4.00X
Direct labor (variable)
y = $0 + $12X
Overhead (mixed)
y = $8,000 + $1.00X
a. Prepare a flexible budget for each of the following activity levels: 550, 600, 650, and 700 direct labor hours.
b. Determine the total cost per direct labor hour at each of the levels of activity.
c. The company normally records 650 direct labor hours during June. Each job typically takes 1.45 hours of labor time. If management wants to earn a profit equal to 40 percent of the costs incurred, what should the charge be to an average lawn care customer?
(Flexible budgets) Tom Snider is a staff accountant for BigBiz. Snider was recently given the task of developing a monthly flexible budget formula for several manufacturing costs. He was told that his equations would be used as an aid in developing future budgets for these manufacturing costs and he was told to put his results into an equation in the form y = a + bX for each cost. Snider gathered data and used high–low analysis to obtain the flexible budget formulas. Rather than using a single activity measure, he decided to use two. Thus, for each manufacturing cost analyzed, he developed two equations. However, after analyzing several equations, Snider became perplexed over his results because the results from the two equations were very different in some cases. Snider has asked you, his colleague, how he should decide which of the two estimated equations for each manufacturing cost he should submit to his boss. To illustrate his dilemma, Snider provided you with his two equations for repairs and maintenance expense, which follow.
(Convert variable to absorption; ethics) Georgia Shacks produces small outdoor buildings. The company began operations in 2010, producing 2,000 buildings and selling 1,500. A variable costing income statement for 2010 follows. During the year, variable production costs per unit were $800 for direct material, $300 for direct labor, and $200 for overhead.
GEORGIA SHACKS
Income Statement (Variable Costing)
For the Year Ended December 31, 2010 Sales $3,750,000
Sales
$3,750,000
Variable cost of goods sold
Beginning inventory
$ 0
Cost of goods manufactured
2,600,000
Cost of goods available for sale
$2,600,000
Less ending inventory
(650,000)
(1,950,000)
Product contribution margin
$1,800,000
Less variable selling and administrative expenses
(270,000)
Total contribution margin
$1,530,000
Less fixed expenses
Fixed factory overhead
$1,500,000
Fixed selling and administrative expenses
190,000
(1,690,000)
Income before taxes
$ (160,000)
The company president is upset about the net loss because he wanted to borrow funds to expand capacity.
a. Prepare a pre tax absorption costing income statement.
b. Explain the source of the difference between the pre tax income and loss figures under the two costing systems.
c. Would it be appropriate to present an absorption costing income statement to the local banker, considering the company president’s knowledge of the net loss deter mined under variable costing? Explain.
d. Assume that during the second year of operations, Georgia Shacks produced 2,000 buildings, sold 2,200, and experienced the same total fixed costs as in 2010. For the second year:
1. Prepare a variable costing pre tax income statement.
2. Prepare an absorption costing pre tax income statement.
3. Explain the difference between the incomes for the second year under the two systems.
(Absorption and variable costing) Bird’s Eye View manufactures satellite dishes used in residential and commercial installations for satellite broadcasted television. For each unit, the following costs apply: $50 for direct material, $100 for direct labor, and $60 for variable overhead. The company’s annual fixed overhead cost is $750,000; it uses expected capacity of 12,500 units produced as the basis for applying fixed overhead to products. A commission of 10 percent of the selling price is paid on each unit sold. Annual fixed selling and administrative expenses are $180,000. The following additional information is available:
2010
2011
Selling price per unit
$ 500
$ 500
Number of units sold
10,000
12,000
Number of units produced
12,500
11,000
Beginning inventory (units)
7,500
10,000
Ending inventory (units)
10,000
?
Prepare pre tax income statements under absorption and variable costing for the years ended 2010 and 2011, with any volume variance being charged to Cost of Goods Sold. Reconcile the differences in income for the two methods.
(Absorption costing vs. variable costing) Since opening in 2009,Akron Aviation has built light aircraft engines and has gained a reputation for reliable and quality products. Factory overhead is applied to production using direct labor hours and any underapplied or overapplied overhead is closed at year end to Cost of Goods Sold. The company’s inventory balances for the past three years and income statements for the past two years follow.
Inventory Balances
12/31/09
12/31/10
12/31/11
Direct Material
$22,000
$30,000
$10,000
Work in Process
Costs
$40,000
$48,000
$64,000
Direct labor hours
1,335
1,600
2,100
Finished Goods
Costs
$25,000
$18,000
$14,000
Direct labor hours
1,450
1,050
820
COMPARATIVE INCOME STATEMENTS
2010
2011
Sales
$840,000
$1,015,000
Cost of goods sold
Finished goods, 1/1
$ 25,000
$ 18,000
Cost of goods manufactured
556,000
673,600
Total available
$581,000
$691,600
Finished goods, 12/31
(18,000)
(14,000)
CGS before overhead adjustment
$563,000
$677,600
Underapplied factory overhead
17,400
19,300
Cost of goods sold
(580,400)
(696,900)
Gross margin
$259,600
$ 318,100
Selling expenses
$ 82,000
$ 95,000
Administrative expenses
70,000
75,000
Total operating expenses
(152,000)
(170,000)
Operating income
$107,600
$ 148,100
The same predetermined OH rate was used to apply overhead to production orders in 2010 and 2011. The rate was based on the following estimates:
Fixed factory overhead
$ 25,000
Variable factory overhead
$155,000
Direct labor cost
$150,000
Direct labor hours
25,000
In 2010 and 2011, actual direct labor hours expended were 20,000 and 23,000, respectively. Raw material costing $292,000 was issued to production in 2010 and $370,000 in 2011. Actual fixed overhead was $37,400 for 2010 and $42,300 for 2011, and the planned direct labor rate per hour was equal to the actual direct labor rate. Actual variable overhead was equal to applied variable overhead.
For both years, all of the reported administrative costs were fixed. The variable portion of the reported selling expenses results from a commission of 5 percent of sales revenue.
a. For the year ending December 31, 2011, prepare a revised income statement using the variable costing method. b. Describe both the advantages and disadvantages of using variable costing.
(Overhead application; absorption costing; ethics; writing) Prior to the start of fiscal 2010, managers of MultiTech hosted a Web conference for their shareholders, financial analysts, and members of the financial press. During the conference, the CEO and CFO released the following financial projections for 2010 to the attendees (amounts in millions):
Sales
$40,000
Cost of Goods Sold
(32,000)
Gross Margin
$ 8,000
Operating expenses
(4,000)
Operating income
$ 4,000
As had been their custom, the CEO and CFO projected confidence that the firm would achieve these goals, even though their projections had been significantly more positive than the actual results for 2009. Not surprisingly, the day following the Web conference, MultiTech’s stock rose 15 percent.
In early October 2010, the CEO and CFO of MultiTech met and developed revised projections for fiscal 2010, based on actual results for the first three quarters of the year and projections for the final quarter. Their revised projections for 2010follow:
Sales
$38,000
Cost of Goods Sold
(30,500)
Gross Margin
$ 7,500
Operating expenses
(4,000)
Operating income
$ 3,500
Upon reviewing these numbers, the CEO turned to the CFO and stated, “I think the market will be forgiving if we come in 5 percent light on the top line (sales), but if we miss operating income by 12.5 percent ($500 ÷ $4,000) our stock is going to get hammered when we announce fourth quarter and annual results.”
The CFO mulled the situation over for a couple of days and started to develop a strategy to increase reported income by increasing production above planned levels. She believed this strategy could successfully move $500 million from Cost of Goods Sold to Finished Goods Inventory. If so, the firm could meet its early profit projections. a. How does increasing production, relative to the planned level of production, decrease Cost of Goods Sold?
b. What other accounts are likely to be affected by a strategy of increasing production to increase income?
c. Is the CFO’s plan ethical? Explain.
d. If you were a stockholder of MultiTech and carefully examined the 2010 financial statements, how might you detect the results of the CFO’s strategy?
(Cost behavior) Toni Rankin has been elected to handle the local Little Theater summer play. The theater has a maximum capacity of 1,000 patrons. Rankin is trying to determine the price to charge Little Theater members for attendance at this year’s performance of The Producers. She has developed the following cost estimates associated with the play:
Cost of printing invitations will be $360 for 100–500; • cost to print between 501 and 1,000 will be $450.
Cost of readying and operating the theater for three evenings will be $900 if attendance is 500 or less; this cost rises to $1,200 if attendance is above 500.
Postage to mail the invitations will be $0.60 each.
Cost of building stage sets will be $1,800.
Cost of printing up to 1,000 programs will be $350.
Cost of security will be $110 per night plus $30 per hour; five hours will be needed each night.
Cost to obtain script usage, $2,000.
Costumes will be donated by several local businesses.
The Little Theater has 300 members, and each member is allowed two guests. Ordinarily only 60 percent of the members attend the summer offering. Of those attending, half bring one guest and the other half bring two guests. The play will be presented from 8 to 11 p.m. each evening. Invitations are mailed to those members calling to say they plan to attend and also to each of the guests they specify. Rankin has asked you to help her by answering the following items.
a. Indicate the type of cost behavior exhibited by each of the items Rankin needs to consider.
b. If the ordinary attendance occurs, what will be the total cost of the summer production?
c. If the ordinary attendance occurs, what will be the cost per person attending?
d. If 90 percent of the members attend and each invites two guests, what will be the total cost of the play? The cost per person? What primarily causes the difference in the cost per person?
(Cost drivers and predictors) Customers now demand a wide variety of “personalized” products and want those products delivered quickly. Factory automa tion is replacing the traditional labor intensive production lines. Thus, product costs are determined when they are “on the drawing board” because, once they are designed, it is difficult to change the method of production or component materials of products.
a. Why is determining the cost to manufacture a product quite a different activity from determining how to control such costs?
b. Why has the advancement of technology made costs more difficult to control?
c. For many production costs, why should “number of units produced” not be considered a cost driver even though it is certainly a valid cost predictor?
(Cost behavior; cost management; ethics) An extremely important and expensive variable cost per employee is health care provided by the employer. This cost is expected to rise each year as more and more expensive technology is used on patients and as the costs of that technology are passed along through the insurance company to the employer. One simple way to reduce these variable costs is to reduce employee insurance coverage.
a. Discuss the ethical implications of reducing employee health care coverage to reduce the variable costs incurred by the employer.
b. Assume that you are an employer with 600 employees. You are forced to reduce some insurance benefits. Your coverage currently includes the following items: mental health coverage, long term disability, convalescent facility care, nonemergency but medically necessary procedures, dependent coverage, and life insurance. Select the two you would eliminate or dramatically reduce and provide reasons for your selections.
c. Prepare a plan that might allow you to “trade” some variable employee health care costs for a fixed or mixed cost.
(Journal entries) The following transactions were incurred by Dimasi Industries during January 2010:
1. Issued $800,000 of direct material to production.
2. Paid 40,000 hours of direct labor at $18 per hour.
3. Accrued 15,500 hours of indirect labor cost at $15 per hour.
4. Recorded $102,100 of depreciation on factory assets.
5. Accrued $32,800 of supervisors’ salaries.
6. Issued $25,400 of indirect material to production.
7. Completed goods costing $1,749,300 and transferred them to finished goods.
a. Prepare journal entries for these transactions using a single overhead account for both variable and fixed overhead. The Raw Material Inventory account contains only direct material; indirect material costs are recorded in Supplies Inventory.
b. If Work in Process Inventory had a beginning balance of $18,900 and an ending balance of $59,600, what amount of manufacturing overhead was included in Work in Process Inventory during January 2010?
(Direct labor; writing) A portion of the costs incurred by business organizations is designated as direct labor cost. As used in practice, the term direct labor cost has a wide variety of meanings. Unless the meaning intended in a given context is clear, maunder standing and confusion are likely to ensue. If a user does not understand the elements included in direct labor cost, erroneous interpretations of the numbers can occur and can result in poor management decisions. In addition to understanding the conceptual definition of direct labor cost, management accountants must understand how direct labor cost should be measured. Discuss the following issues:
a. Distinguish between direct labor and indirect labor.
b. Discuss why some nonproductive labor time (such as coffee breaks and personal time) can be and often is treated as direct labor whereas other nonproductive time (such as downtime and training) is treated as indirect labor.
c. Following are labor cost elements that a company has classified as direct labor, manufacturing overhead, or either category depending on the situation.
Direct labor: Included in the company’s direct labor are e cost production efficiency bonuses and certain benefits for direct labor workers such as FICA (employer’s portion), group life insurance, vacation pay, and workers’ compensation insurance.
Manufacturing overhead: Included in the company’s overhead are costs for wage continuation plans in the event of illness, the company sponsored cafeteria, the personnel department, and recreational facilities.
Direct labor or manufacturing overhead: Included in this category are maintenance expenses, overtime premiums, and shift premiums.
Explain the rationale used by the company in classifying the cost elements in each of the three categories.
d. The two aspects of measuring direct labor costs are (1) the quantity of labor effort that is to be included, and (2) the unit price by which the labor quantity is multiplied to arrive at labor cost. Why are these considered separate and distinct aspects of measuring labor cost?
(Ethics) You are the chief financial officer for a small manufacturing company that has applied for a bank loan. In speaking with the bank loan officer, you are told that two minimum criteria for granting loans are (1) a 40 percent gross margin and (2) operating income of at least 15 percent of sales. Looking at the last four months’ income statements, you find that gross margin has been between 30 and 33 percent, and operating income ranged from 18 to 24 percent of sales. You discuss these relationships with the company president, who suggests that some of the product costs included in Cost of Goods Sold should be moved to the selling and administrative categories so that the income statement will conform to the bank’s criteria.
a. Which types of product costs might be most easily reassigned to period cost classifications?
b. Because the president is not suggesting that any expenses be kept off the income statement, do you see any ethical problems with the request? Discuss the rationale for your answer.
c. Write a short memo to convince the banker to loan funds to the company in spite of its noncompliance with the specified loan criteria.
(CGM; journal entries) Designer Rags makes evening dresses. The following information was gathered from the company records for 2010, the first year of company operations. Work in Process Inventory at the end of 2010 was $31,500.
Direct material purchased on account
$1,110,000
Direct material issued to production
894,000
Direct labor payroll accrued
645,000
Indirect labor payroll accrued
186,000
Prepaid factory insurance expired
6,000
Factory utilities paid
42,900
Depreciation on factory equipment recorded
65,100
Factory rent paid
252,000
Sales (all on account)
2,862,000
The company’s gross profit rate for the year was 35 percent.
a. Compute the cost of goods sold for 2010.
b. What was the total cost of goods manufactured for 2010?
c. What is Finished Goods Inventory at December 31, 2010?
d. If net income was $250,000, what were total selling and administrative expenses for the year?
e. Prepare journal entries to record the flow of costs for the year, assuming the company uses a perpetual inventory system and a single Manufacturing Overhead Control account and that actual overhead is included in WIP Inventory.
(OH allocation; writing) In a manufacturing company, overhead allocations are made for three reasons: (1) to determine the full cost of a product; (2) to encourage efficient resource usage; and (3) to compare alternative courses of action for management purposes.
a. Why must overhead be considered a product cost under generally accepted accounting principles?
b. Ryan Company makes plastic dog carriers. The manufacturing process is highly automated and the machine time needed to make any size crate is approximately the same. Ryan’s management decides to begin producing plastic lawn furniture and, to do so, two additional pieces of automated equipment are acquired. Annual depreciation on the new pieces of equipment is $38,000. Should the new overhead cost be allocated over all products manufactured by Ryan? Explain.
c. What one specific reason would make the use of a normal cost system more logical for a business located in Michigan than for one located in Hawaii?
(CGM; CGS) Flex Em began business in July 2010. The firm makes an exercise machine for home and gym use. Following are data taken from the firm’s accounting records that pertain to its first month of operations.
Direct material purchased on account
$ 900,000
Direct material issued to production
377,000
Direct labor payroll accrued
126,800
Indirect labor payroll paid
40,600
Factory insurance expired
6,000
Factory utilities paid
17,800
Factory depreciation recorded
230,300
Ending Work in Process Inventory
51,000
Ending Finished Goods Inventory (30 units)
97,500
Sales on account ($5,200 per unit)
1,040,000
a. How many units did the company sell in July 2010?
b. Prepare a schedule of cost of goods manufactured for July 2010.
c. How many units were completed in July?
d. What was the per unit cost of goods manufactured for the month?
e. What was the cost of goods sold in the first month of operations?
(Missing data) Rapid Response Manufacturing Company suffered major losses in a fire on June 18, 2010. In addition to destroying several buildings, the blaze destroyed the company’s Work in Process Inventory for an entire product line. Fortunately, the company was insured; however, it needs to substantiate the amount of the claim. To this end, the company has gathered the following information that pertains to production and sales of the affected product line:
1. The company’s sales for the first 18 days of June amounted to $460,000. Normally, this product line generates a gross profit equal to 40 percent of sales.
2. Finished Goods Inventory was $58,000 on June 1 and $85,000 on June 18.
3. On June 1, Work in Process Inventory was $96,000.
4. During the first 18 days of June, the company incurred the following costs:
Direct material used
$152,000
Direct labor
88,000
Manufacturing overhead
84,000
a. Determine the value of Work in Process Inventory that was destroyed by the fire, assuming Rapid Response Manufacturing Company uses an actual cost system.
b. What other information might the insurance company require? How would management determine or estimate this information?
White Laser Company management uses predetermined VOH and FOH rates to apply overhead to its products. For 2009, the company budgeted production at 27,000units, which would require 54,000 direct labor hours (DLHs) and 27,000 machine hours (MHs). At that level of production, total variable and fixed manufacturing over head costs were expected to be $13,500 and $105,300, respectively. Variable over head is applied to production using direct labor hours, and fixed overhead is applied using machine hours. During 2009, White Laser Company produced 23,000 units and experienced the following operating statistics and costs: 46,000 direct labor hours; 23,000 machine hours; $11,980 actual variable manufacturing overhead; and$103,540 actual fixed manufacturing overhead. By the end of 2009, all 23,000 units that were produced were sold; thus, the company began 2010 with no beginning finished goods inventory.
In 2010 and 2011, White Laser Company management decided to apply manufacturing overhead to products using units of production (rather than direct labor hours and machine hours). The company produced 25,000 and 20,000 units, respectively, in 2010 and 2011. White Laser’s budgeted and actual fixed manufacturing overhead for both years was $100,000. Production in each year was projected at 25,000 units. Variable production cost (including variable manufacturing overhead) is $3 per unit.
The following absorption costing income statements and supporting information are available:
2010
2011
Net sales (20,000 units and 22,000 units)
$300,000
$330,000
Cost of goods sold (a)
(140,000)
(154,000)
Volume variance (0 and 5,000 units × $4)
0
(20,000)
Gross margin
$160,000
$156,000
Operating expenses (b)
(82,500)
(88,500)
Income before tax
$ 77,500
$ 67,500
(a) Cost of goods sold
Beginning inventory
$ 0
$ 35,000
Cost of goods manufactured
175,000
140,000
Goods available for sale
$175,000
$175,000
Ending inventory
(35,000)
(21,000)
Cost of goods sold
$140,000
$154,000
aCGM
25,000 units × $7 (of which $3 are variable) = $175,000
20,000 units × $7 (of which $3 are variable) = $140,000
a. Determine the predetermined variable and fixed overhead rates for 2009, and calculate how much underapplied or overapplied overhead existed at the end of that year.
b. Recast the 2010 and 2011 income statements on a variable costing basis.
c. Reconcile income for 2010 and 2011 between absorption and variable costing.
Why would regression analysis provide a more accurate cost formula than the high–low method for a mixed cost?
How does absorption costing differ from variable costing in cost accumulation and income statement presentation?
What is meant by classifying costs (a) functionally and (b) behaviorally? Why would a company be concerned about functional and behavioral classifications?
Is variable or absorption costing generally required for external reporting? Why is this method preferred to the alternative?
Why does variable costing provide more useful information than absorption costing for making internal decisions?
What are the income relationships between absorption and variable costing when production volume differs from sales volume? What causes these relationships to occur?
(Predetermined OH rates) Lansing Mfg. prepared the following 2010 abbreviated flexible budget for different levels of machine hours:
40,000
44,000
48,000
52,000
Variable manufacturing overhead
$ 80,000
$ 88,000
$ 96,000
$104,000
Fixed manufacturing overhead
325,000
325,000
325,000
325,000
Each product requires 4 hours of machine time, and the company expects to produce10,000 units in 2010. Production is expected to be evenly distributed throughout the year.
a. Calculate separate predetermined variable and fixed OH rates using as the basis of application (1) units of production and (2) machine hours.
b. Calculate the combined predetermined OH rate using (1) units of product and (2) machine hours.
c. Assume that all actual overhead costs are equal to expected overhead costs in 2010, but that Lansing Mfg. produced 11,000 units of product. If the separate rates based on units of product calculated in part (a) were used to apply overhead, what amounts of underapplied or overapplied variable and fixed overhead exist at year end 2010?
(Underapplied or overapplied overhead) At the end of 2010, Jackson Tank Company’s accounts showed a $66,000 credit balance in Manufacturing Overhead Control. In addition, the company had the following account balances:
Work in Process Inventory
$384,000
Finished Goods Inventory
96,000
Cost of Goods Sold
720,000
a. Prepare the necessary journal entry to close the overhead account if the balance is considered immaterial.
b. Prepare the necessary journal entry to close the overhead account if the balance is considered material.
c. Which method do you believe is more appropriate for the company and why?
(Predetermined OH rates and underapplied/overapplied OH) Davidson’s Dolls had the following information in its Work in Process Inventory account for June 2010:
Work in Process Inventory
Beginning balance
10,000
Transferred out
335,000
Materials added
150,000
Labor (5,000 DLHs)
90,000
Applied overhead
120,000
Ending balance
35,000
All workers are paid the same rate per hour. Factory overhead is applied to Work in Process Inventory on the basis of direct labor hours. The only work left in process at the end of the month had a total of 2,860 direct labor hours accumulated to date.
a. What is the total predetermined OH rate per direct labor hour?
b. If actual total overhead for June is $121,500, what is the amount of underapplied or overapplied overhead?
c. Given your answer to part (b), how would you recommend the over or underap plied overhead be closed?
(Underapplied or overapplied overhead) At year end 2010, Dub’s Wind Generator Co. had a $40,000 debit balance in its Manufacturing Overhead Control account. Overhead is applied to products based on direct labor cost. Relevant account balance information at year end follows:
Work in Process
Finished Goods
Cost of Goods
Inventory
Inventory
Sold
Direct material
$20,000
$ 80,000
$120,000
Direct labor
10,000
40,000
50,000
Factory overhead
20,000
80,000
100,000
$50,000
$200,000
$270,000
a. What predetermined OH rate was used during the year?
b. Provide arguments to be used for deciding whether to prorate the balance in the overhead account at year end.
c. Prorate the overhead account balance based on the relative balances of the appropri ate accounts.
d. Identify some possible reasons that the company had a debit balance in the over head account at year end.
(Organizational constraints; writing) Three common organizational constraints are monetary capital, intellectual capital, and technology. Additionally, the environment in which the organization operates may present one or more types of constraints: cultural, fiscal, legal/regulatory, or political.
a. Discuss whether each of these constraints would be influential in the following types of organizations:
1. city hall of a major metropolitan city
2. a franchised quick copy business
3. a new firm of attorneys, all of whom recently graduated from law school
4. an international oil exploration and production company
b. For each of the previously listed organizations, discuss your perceptions about which of the constraints would be most critical and why.
(Ethics; writing) You have recently been elected President of the United States.
One of your most popular positions is that you want to reduce the costs of doing business in the United States. When asked how you intended to accomplish this, you replied, “By seeking to repeal all laws that create unnecessary costs. Repealing such laws will be good not only for business but also for the consumer since product costs and, therefore, selling prices will be reduced.” Congress heard the message loud and clear and has decided to repeal all environmental protection laws.
a. Discuss the short term and long term implications of such a policy.
b. How would such a policy affect the global competitiveness of U.S. companies?
c. What reactions would you expect to such a policy from (1) other industrialized nations and (2) developing countries?
(Association with cost object) Chase University’s College of Business has five departments: Accounting, Economics, Finance, Management, and Marketing. Each department chairperson is responsible for the department’s budget preparation. Indicate whether each of the following costs incurred in the Accounting Department is direct or indirect to the department:
a. Accounting faculty salaries
b. Accounting chairperson’s salary
c. Cost of computer time of university server used by members of the department
d. Cost of office assistant salaries (office assistants are shared by the entire college)
e. Cost of travel by department faculty paid from externally generated funds contributed directly to the department
f. Cost of equipment purchased by the department from allocated state funds
g. Depreciation allocation of the college building cost for the number of offices used by department faculty
h. Cost of periodicals/books purchased by the department
i. Long distance telephone calls made by accounting faculty
(Association with cost object) Morris & Assoc., owned by Cindy Morris, provides accounting services to clients. The firm has two accountants (Jo Perkins who performs basic accounting services and Steve Tompkin who performs tax services) and one office assistant. The assistant is paid on an hourly basis for the actual hours worked. One client the firm served during April was Vic Kennedy. During April 2010, the following labor time was incurred. Classify the labor time as direct or indirect based on whether the cost object is (1) Kennedy’s services, (2) tax services provided, or (3) the accounting firm.
a. Four hours of Perkins’s time in preparing Kennedy’s financial statements
b. Six hours of the assistant’s time in copying Kennedy’s tax materials
c. Three hours of Morris’s time playing golf with Kennedy
d. Eight hours of continuing education paid for by the firm for Tompkin to attend a tax update seminar
e. One hour of the assistant’s time spent at lunch on the day that Kennedy’s tax return was prepared
f. Two hours of Perkins’s time spent with Kennedy and his banker discussing Kennedy’s financial statements
g. One half hour of Tompkin’s time spent talking to an IRS agent about a deduction taken on Kennedy’s tax return
h. Forty hours of janitorial wages
i. Seven hours of Tompkin’s time preparing Kennedy’s tax return
(Cost behavior) Merry Olde Games produces croquet sets. The company makes fixed monthly payments to the local utility based on the previous year’s electrical usage.
Any difference between actual and expected usage is paid in January of the year following usage. In February 2010, Merry Olde Games made 2,000 croquet sets and incurred the following costs:
Cardboard boxes (1 per set)
$ 1,000
Mallets (2 per set)
12,000
Croquet balls (6 per set)
9,000
Wire hoops (12 per set, including extras)
3,600
Total hourly wages for production workers
8,400
Supervisor’s salary
2,600
Building and equipment rental
2,800
Utilities
1,300
Total
$40,700
a. What was the per unit cost of each component of a croquet set?
b. What was the total cost of each croquet set?
c. Production for March 2010 is expected to be 2,500 croquet sets. Last November, when 2,500 sets were made, utility cost was $1,400. There have been no rate changes at the local utility companies since that time. What is the estimated cost per set for March?
(Cost behavior) The next winner of America’s Idol will perform at your fraternity’s charity event for free at your school’s basketball arena (25,000 person capacity) on January 28, 2011. The school is charging your fraternity $37,500 for the facilities and $10 for each ticket sold. The fraternity asks you, their only numbers astute member, to determine how much to charge for each ticket. The group wants to make a profit of $8 per ticket sold. You assume that 15,000 tickets will be sold.
a. What is the total cost incurred by the fraternity if 15,000 tickets are sold?
b. What price per ticket must be charged for the fraternity to earn its desired profit margin?
c. Suppose that on the morning of January 28, 2011, a major snowstorm hits your area, bringing in 36 inches of snow and ice. Only 5,000 tickets are sold because most students were going to buy their tickets at the door. What is the total profit or loss to the fraternity?
d. What assumptions did you make about your calculations that should have been conveyed to the fraternity?
e. Suppose instead that fair weather prevails and, by show time, 20,000 concert tickets are sold. What is the total profit or loss to the fraternity?
(Cost behavior and classification) Indicate whether each of the following items is a variable (V), fixed (F), or mixed (M) cost and whether it is a product/ service (PT) or period (PD) cost. If some items have alternative answers, indicate the alternatives and the reasons for them.
a. Wages of factory maintenance workers
b. Wages of forklift operators who move finished goods from a central warehouse to the outbound loading dock
c. Insurance premiums paid on the headquarters of a manufacturing company
d. Cost of labels attached to shirts made by a company
e. Property taxes on a manufacturing plant
f. Paper towels used in factory restrooms
g. Salaries of office assistants in a law firm
h. Freight costs of acquiring raw material from suppliers
i. Computer paper used in an accounting firm
j. Cost of wax to make candles
k. Freight in on a truckload of furniture purchased for resale
(Product cost classifications) In June 2010, Carolyn Gardens incurred the following costs. One of several projects in process during the month was a landscaped terrace for Pam Beattie. Relative to the Beattie landscaping job, classify each of the costs as direct material, direct labor, or overhead. The terrace required two days to design and one five day work week to complete. Some costs may not fit entirely into a single classification; in such cases, and if possible, provide a systematic and rational method to allocate such costs.
Mulch purchased for Beattie’s landscaping
$ 320
June salary of Z. Trumble, the landscape designer, who worked 20 days in June
3,000
Construction permit for Beattie’s landscaping
95
Gardeners’ wages; all worked on Beattie’s landscaping; gardeners work eight hours per day, five days per week; 20 working days in June
3,840
June depreciation on the company loader, driven by a gardener and used on Beattie’s landscaping one day
200
Landscaping rock purchased for Beattie’s landscaping
1,580
June rent on Carolyn Gardens offices, where Z. Trumble has an office that occupies 150 square feet of 3,000 total square feet
2,400
June utility bills for Carolyn Gardens
1,800
Plants and pots purchased for Beattie’s landscaping
(Labor cost classification) Woodlands Restaurant Supply operates in two shifts, paying a late shift premium of 10 percent and an overtime premium of 75 percent. The May 2010 payroll follows:
Total wages for 6,000 hours
$54,000
Normal hourly employee wage
$9
Total regular hours worked, split evenly between the shifts
5,000
All overtime was worked by the early shift during May. Shift and overtime premiums are considered part of overhead rather than direct labor.
a. How many overtime hours were worked in May?
b. How much of the total labor cost should be charged to direct labor? To overhead?
c. What amount of overhead was for second shift premiums? For overtime premiums?
(Labor cost classification) Tidy House produces a variety of household products.
The firm operates 24 hours per day with three daily work shifts. The first shift workers receive “regular pay.” The second shift receives an 8 percent pay premium, and the third shift receives a 12 percent pay premium. In addition, when production is scheduled on weekends, the firm pays an overtime premium of 50 percent (based on the pay rate for first shift employees). Labor premiums are included in overhead. The October 2010 factory payroll is as follows:
Total wages for October for 32,000 hours
$435,600
Normal hourly wage for first shift employees
$12
Total regular hours worked, split evenly among the three shifts
27,000
a. How many overtime hours were worked in October?
b. How much of the total labor cost should be charged to direct labor? To overhead?
c. What amount of overhead was for second shift and third shift premiums? For overtime premiums?
(OH allocation) Tamra Corp. makes one product line. In February 2010, Tamra paid $530,000 in factory overhead costs. Of that amount, $124,000 was for January’s factory utilities and $48,000 was for property taxes on the factory for the year 2010.
February’s factory utility bill arrived on March 12, 2010, and was only $81,000 because the weather was significantly milder than in January. Tamra Corp. produced 50,000 units of product in both January and February 2010.
a. What were Tamra’s actual factory overhead costs for February 2010?
b. Actual per unit direct material and direct labor costs for February 2010 were $24.30 and $10.95. What was actual total product cost for February?
c. Assume that, other than factory utilities, all direct material, direct labor, and overhead costs for Tamra Corp. were equal in January 2010 and February 2010.
Will product cost for the two months differ? How can such differences be avoided?
(CGM; CGS) The cost of goods sold in March 2010 for Targé Co. was $2,644,100. March 31 Work in Process Inventory was 25 percent of the March 1 Work in Process Inventory. Overhead was 225 percent of direct labor cost. During March, $1,182,000 of direct material was purchased. Other March information follows:
Inventories
March 1
March 31
Direct Material
$ 30,000
$ 42,000
Work in Process
90,000
?
Finished Goods
125,000
18,400
a. Prepare a schedule of the cost of goods sold for March.
b. Prepare the March cost of goods manufactured schedule.
c. What was the amount of prime cost incurred in March?
d. What was the amount of conversion cost incurred in March?
(Service industry; journal entries and CSR) Kalogrides & McMillan CPAs incurred the following costs in performing audits during September 2010. The firm uses a Work in Process Inventory account for audit engagement costs and records overhead in fixed and variable overhead accounts.
a. Prepare journal entries for each of the following transactions:
Used $5,000 of previously • y purchased supplies on audit engagements.
Paid $8,000 of partner travel expenses to an accounting conference.
Recorded $6,500 of depreciation on laptops used in audits.
Recorded $1,800,000 of annual depreciation on the Kalogrides & McMillan Building, located in downtown New York; 65 percent of the space is used to house audit personnel.
Accrued audit partner salaries, $200,000.
Accrued remaining audit staffsalaries, $257,900.
Paid credit card charges for travel costs for client engagements, $19,400.
One month’s prepaid insurance and property taxes expired on the downtown building, $17,300.
Accrued $3,400 of office assistant wages; the office assistant works only for the audit partners and staff.
Paid all accrued salaries and wages for the month.
b. Determine the cost of audit services rendered for September 2010.
(Cost of services rendered) The following information is related to the Lilliput Veterinary Clinic for April 2010, the firm’s first month of operation:
Veterinarian salaries for April
$16,200
Assistants’ salaries for April
6,280
Medical supplies purchased in April
4,800
Utilities for month (90% related to animal treatment)
2,700
Office salaries for April (20% related to animal treatment)
(Cost classifications) GeoffPayne painted four houses during April 2010.
For these jobs, he spent $1,200 on paint, $80 on mineral spirits, and $300 on brushes. He also bought two pairs of coveralls for $100 each; he wears coveralls only while he works. During the first week of April, Payne placed a $100 ad for his business in the classifieds. He hired an assistant for one of the painting jobs; the assistant was paid $25 per hour and worked 50 hours.
Being a very methodical person, Payne kept detailed records of his mileage to and from each painting job. The average operating cost per mile for his van is $0.70. He found a $30 receipt in his van for a metropolitan map that he purchased in April. He uses the map as part of a contact file for referral work and for bids that he has made on potential jobs. He also had $30 in receipts for bridge tolls ($2 per trip) for a painting job he did across the river.
Near the end of April, Payne decided to go camping, and he turned down a job on which he had bid $6,000. He called the homeowner long distance (at a cost of $3.20) to explain his reasons for declining the job.
Using the following headings, indicate how to classify each of the April costs incurred by Payne. Assume that the cost object is a house painting job.
(Cost behavior) PlumView Printers makes stationery sets of 100 percent rag content edged in 24 karat gold. In an average month, the firm produces 80,000 boxes of stationery; each box contains 100 pages of stationery and 80 envelopes. Production costs are incurred for paper, ink, glue, and boxes. The company manufactures this product in batches of 500 boxes of a specific stationery design. The following data have been extracted from the company’s accounting records for June 2010:
Cost of paper for each batch
$10,000
Cost of ink and glue for each batch
1,000
Cost of 1,000 gold boxes for each batch
32,000
Direct labor for producing each batch
16,000
Cost of designing each batch
20,000
Overhead charges total $408,000 per month and are considered fully fixed for purposes of cost estimation.
a. What is the cost per box of stationery based on average production volume?
b. If sales volume increases to 120,000 boxes per month, what will be the cost per box (assuming that cost behavior patterns remain the same as in June)?
c. If sales volume increases to 120,000 boxes per month but the firm does not want the cost per box to exceed its current level [based on part (a)], what amount can the company pay for design costs, assuming all other costs are the same as June levels?
d. Assume that PlumView Printers is now able to sell, on average, each box of stationery at a price of $195. If the company is able to increase its volume to 120,000 boxes per month, what sales price per box will generate the same per unit gross margin that the firm is now achieving on 80,000 boxes per month?
e. Would it be possible to lower total costs by producing more boxes per batch, even if the total volume of 80,000 is maintained? Explain.
The Edge Company makes specialty skates for the ice skating circuit. On December 31, 2010, the company had (a) 500 skates in finished goods inventory and (b) 2,000 blades at a cost of $15 each in raw materials inventory. During 2011, Edge Company purchased 45,000 additional blades at $15 each and manufactured 20,000 pairs of skates.
Required
1. Determine the unit and dollar amounts of raw materials inventory in blades at December 31, 2011.
Analysis Component
2. Write a one half page memorandum to the production manager explaining why a just in time inventory system for blades should be considered. Include the amount of working capital that can be reduced at December 31, 2011, if the ending blade raw material inventory is cut in half.
Shown here are annual financial data at December 31, 2011, taken from two different companies.
Cardinal Drug(Retail)
Nandina (Manufacturing)
Beginning inventory
Merchandise
$ 50,000
Finished goods
$200,000
Cost of purchases
350,000
Cost of goods manufactured
686,000
Ending inventory
Merchandise
25,000
Finished goods
300,000
Required
1. Compute the cost of goods sold section of the income statement at December 31, 2011, for each company.
Include the proper title and format in the solution.
2. Write a half page memorandum to your instructor (a) identifying the inventory accounts and (b) identifying where each is reported on the income statement and balance sheet for both companies.
Eastman Kodak manufactures digital cameras and must compete on lean manufacturing concepts. Match each of the following activities that it engages in with the lean manufacturing concept it strives to achieve.
(Some activities might relate to more than one lean manufacturing concept.)
1. Kodak monitors the market to determine what features its competitors are offering on digital cameras.
a. Just in time (JIT)
2. Kodak asks production workers for ideas to improve production.
b. Continuous improvement (CI)
3. Lenses are received daily based on customer orders.
c. Total quality management (TQM)
4. Customers receive a satisfaction survey with each camera purchased.
5. The manufacturing process is standardized and documented.
6. Cameras are produced in small lots, and only to customer order.
7. Manufacturing facilities are arranged to reduce move time and wait time.
8. Kodak conducts focus groups to determine new features that customers want in digital cameras.
9. Orders received are filled within two business days.
10. Kodak works with suppliers to reduce inspection time of incoming materials.
Quick Dry Ink produces ink jet printers for personal computers. It received an order for 600 printers from a customer. The following information is available for this order.
Process time
16.0 hours
Inspection time
3.4 hours
Move time
9.0 hours
Wait time
21.6 hours
Required
1. Compute the company’s manufacturing cycle time.
2. Compute the company’s manufacturing cycle efficiency. Interpret your answer.
Analysis Component
3. Assume that Quick Dry Ink wishes to increase its manufacturing cycle efficiency to 0.80. What are some ways that it can accomplish this?
On October 1, 2011, Santana Rey launched a computer services company, Business Solutions, that offers consulting services, system installation, and custom program development. In late 2011 Santana decides to diversify her business by also manufacturing computer workstation furniture.
Required
Classify the following manufacturing costs of Business Solutions by behavior and traceability.
Managerial accounting is more than recording, maintaining, and reporting financial results.
Managerial accountants must provide managers with both financial and nonfinancial information including estimates, projections, and forecasts. There are many accounting estimates that management accountants must make, and Research In Motion must notify shareholders of these estimates.
Required
1. Access and read Research In Motion’s “Use of Estimates” section of the “Summary of Significant
Accounting Policies” footnote to its financial statements, from Appendix A. What are some of the accounting estimates that Research In Motion made in preparing its financial statements? What are some of the effects if the company’s actual results differ from its estimates?
2. What is the management accountant’s role in determining those estimates?
Fast Forward
3. Access Research In Motion’s annual report for a fiscal year ending after February 27, 2010, from either its Website or the SEC’s EDGAR database. Answer the questions in parts (1) and (2) after reading the current “Summary of Significant Accounting Policies”. Identify any major changes.
Manufacturing companies must decide whether to operate their own manufacturing facilities or instead outsource the manufacturing function to a third party (outside) company. This decision impacts both company managers and also financial statement items. Access the annual report or 10 K for both Research In Motion (RIM) and Apple. The RIM report is for the year ended February 27, 2010 and the
Apple report is for the year ended September 26, 2009.
Required
1. Determine whether RIM operates its own manufacturing facilities or outsources the manufacturing function.
2. Determine whether Apple operates its own manufacturing facilities or outsources the manufacturing function.
3. For both companies, determine the amounts they report for (a) raw materials inventory, (b) work in process inventory, and (c) finished goods inventory. Explain how the decision on outsourcing (or not) of manufacturing operations is related to the components of inventory.
Assume that you are the managerial accountant at Infostore, a manufacturer of hard drives, CDs, and DVDs. Its reporting year end is December 31. The chief financial officer is concerned about having enough cash to pay the expected income tax bill because of poor cash flow management. On November 15, the purchasing department purchased excess inventory of CD raw materials in anticipation of rapid growth of this product beginning in January. To decrease the company’s tax liability, the chief financial officer tells you to record the purchase of this inventory as part of supplies and expense it in the current year; this would decrease the company’s tax liability by increasing expenses.
Required
1. In which account should the purchase of CD raw materials be recorded?
2. How should you respond to this request by the chief financial officer?
The following calendar year information is taken from the December 31, 2011, adjusted trial balance and other records of Azalea Company.
Advertising expense
$ 19,125
Direct labor
$ 650,750
Depreciation expense—Office equipment
8,750
Indirect labor
60,000
Depreciation expense—Selling equipment
10,000
Miscellaneous production costs
8,500
Depreciation expense — Factory equipment
32,500
Office salaries expense
100,875
Factory supervision
122,500
Raw materials purchases
872,500
Factory supplies used
15,750
Rent expense—Office space
21,125
Factory utilities
36,250
Rent expense—Selling space
25,750
Inventories
Rent expense—Factory building
79,750
Raw materials, December 31, 2010
177,500
Maintenance expense—Factory equipment
27,875
Raw materials, December 31, 2011
168,125
Sales
3,275,000
Goods in process, December 31, 2010
15,875
Sales discounts
57,500
Goods in process, December 31, 2011
14,000
Sales salaries expense
286,250
Finished goods, December 31, 2010
164,375
Finished goods, December 31, 2011
129,000
Required
1. Each team member is to be responsible for computing one of the following amounts. You are not to duplicate your teammates’ work. Get any necessary amounts from teammates. Each member is to explain the computation to the team in preparation for reporting to class.
a. Materials used. d. Total cost of goods in process.
b. Factory overhead. e. Cost of goods manufactured.
c. Total manufacturing costs.
2. Check your cost of goods manufactured with the instructor. If it is correct, proceed to part (3).
3. Each team member is to be responsible for computing one of the following amounts. You are not to duplicate your teammates’ work. Get any necessary amounts from teammates. Each member is to explain the computation to the team in preparation for reporting to class.
a. Net sales. d. Total operating expenses.
b. Cost of goods sold. e. Net income or loss before taxes.
1. Which of these projects is likely to have the higher asset beta, other things equal? Why?
a. The sales force for project A is paid a fixed annual salary. Project B’s sales force is paid by commissions only.
b. Project C is a first class only airline. Project D is a well established line of breakfast cereals.
2. True or false?
a. The company cost of capital is the correct discount rate for all projects, because the high risks of some projects are offset by the low risk of other projects.
b. Distant cash flows are riskier than near term cash flows. Therefore long term projects require higher risk adjusted discount rates.
c. Adding fudge factors to discount rates undervalues long lived projects compared with quick payoff projects.
a. What is the firm’s asset beta? ( Hint: What is the beta of a portfolio of all the firm’s securities?)
b. Assume that the CAPM is correct. What discount rate should Nero set for investments that expand the scale of its operations without changing its asset beta? Assume a risk free interest rate of 5% and a market risk premium of 6%.
The following table shows estimates of the risk of two well known Canadian stocks:
Standard Deviation, %
R2
Beta
Standard Error of Beta
Toronto Dominion Bank
25
.25
.82
.18
Canadian Pacific
28
.30
1.04
.20
a. What proportion of each stock’s risk was market risk, and what proportion was specific risk?
b. What is the variance of Toronto Dominion? What is the specific variance?
c. What is the confidence interval on Canadian Pacific’s beta?
d. If the CAPM is correct, what is the expected return on Toronto Dominion? Assume a risk free interest rate of 5% and an expected market return of 12%.
e. Suppose that next year the market provides a zero return. Knowing this, what return would you expect from Toronto Dominion?
You are given the following information for Golden Fleece Financial:
Long term debt outstanding:
$300,000
Current yield to maturity (r debt):
8%
Number of shares of common stock:
10,000
Price per share:
$50
Book value per share:
$25
Expected rate of return on stock (r equity):
15%
Calculate Golden Fleece’s company cost of capital. Ignore taxes.
2. Look again at Table 9.1 . This time we will concentrate on Burlington Northern.
a. Calculate Burlington’s cost of equity from the CAPM using its own beta estimate and the industry beta estimate. How different are your answers? Assume a risk free rate of 5% and a market risk premium of 7%.
b. Can you be confident that Burlington’s true beta is not the industry average?
c. Under what circumstances might you advise Burlington to calculate its cost of equity based on its own beta estimate?
The McGregor Whisky Company is proposing to market diet scotch. The product will first be test marketed for two years in southern California at an initial cost of $500,000. This test launch is not expected to produce any profits but should reveal consumer preferences. There is a 60% chance that demand will be satisfactory. In this case McGregor will spend $5 million to launch the scotch nationwide and will receive an expected annual profit of $700,000 in perpetuity. If demand is not satisfactory, diet scotch will be withdrawn.
Once consumer preferences are known, the product will be subject to an average degree of risk, and, therefore, McGregor requires a return of 12% on its investment. However, the initial test market phase is viewed as much riskier, and McGregor demands a return of 20% on this initial expenditure.
An oil company executive is considering investing $10 million in one or both of two wells: well 1 is expected to produce oil worth $3 million a year for 10 years; well 2 is expected to produce $2 million for 15 years. These are real (inflation adjusted) cash flows. The beta for producing wells is .9. The market risk premium is 8%, the nominal risk free interest rate is 6%, and expected inflation is 4%. The two wells are intended to develop a previously discovered oil field. Unfortunately there is still a 20% chance of a dry hole in each case. A dry hole means zero cash flows and a complete loss of the $10 million investment. Ignore taxes and make further assumptions as necessary.
a. What is the correct real discount rate for cash flows from developed wells?
b. The oil company executive proposes to add 20 percentage points to the real discount rate to offset the risk of a dry hole. Calculate the NPV of each well with this adjusted discount rate.
c. What do you say the NPVs of the two wells are?
d. Is there any single fudge factor that could be added to the discount rate for developed wells that would yield the correct NPV for both wells? Explain.
Flexibility is said to be the hallmark of modern management accounting, whereas standardization and consistency describe financial accounting. Explain why the focus of these two accounting systems differs.
Why are legally binding cost accounting standards more critical for defense contractors than for other entities?
Why would operating in a global (rather than a strictly domestic) marketplace create a need for additional information for managers? Discuss some of the additional information managers would need and why such information would be valuable.
Why is a mission statement important to an organization?
What is organizational strategy? Why would each organization have a unique strategy or set of strategies?
(Accounting information; writing) You are a partner in a local accounting firm that does financial planning and prepares tax returns, payroll, and financial reports for medium size companies. Your monthly financial statements show that your organization is consistently profitable. Cash flow is becoming a small problem, however, and you need to borrow from your bank. You have also been receiving some customer complaints about time delays and price increases.
a. What accounting information do you think is most important to take with you to discuss a possible loan with your banker?
b. What accounting information do you think is most important to address the issues of time delays and price increases in your business? What no accounting information is important?
c. Can the information in parts (a) and (b) be gathered from the organization’s books and records directly? Indirectly? If the information cannot be obtained from internal records, where would you obtain such information?
(Interview; research) Call a local company and set up an interview with the firm’s cost or management accountant. The following questions can be used as starting points for the interview:
• What is your educational background?
• What was your career path to attain this position?
• What are your most frequently recurring tasks?
• What aspects of your job do you find to be the most fun? The most challenging?
• What college courses would be the most helpful in preparing a person for your job?
• Why did you select these courses?
a. Compare and contrast your interview answers with those of other students in the class.
b. Which one or two items from the interview were of the most benefit to you? Why?
(Mission statement; writing) You have managed Indiana’s Best Appliances franchises for 15 years and have 100 employees. Business has been profitable, but you are concerned that the Fort Wayne locations could soon experience a downturn in growth. You have decided to prepare for such an event by engaging in a higher level of strategic planning, beginning with a company mission statement.
a. How does a mission statement add strength to the strategic planning process?
b. Who should be involved in developing a mission statement and why?
c. What factors should be considered in the development of a mission statement? Why are these factors important?
d. Prepare a mission statement for Best Appliances and discuss how your mission statement will provide benefits to strategic planning.
Compute and interpret (a) manufacturing cycle time and (b) manufacturing cycle efficiency using the following information from a manufacturing company.
Both managerial accounting and financial accounting provide useful information to decision makers. Indicate in the following chart the most likely source of information for each business decision (a decision can require major input from both sources, in which case both can be marked).
Primary Information Source
Business Decision
Managerial
Managerial
1. Plan the budget for next quarter
____
____
2. Measure profitability of all individual stores
____
____
3. Prepare financial reports according to GAAP
____
____
4. Determine location and size for a new plant
____
____
5. Determine amount of dividends to pay stockholders
____
____
6. Evaluate a purchasing department’s performance
____
____
7. Report financial performance to board of directors
In the following chart, compare financial accounting and managerial accounting by describing how each differs for the items listed. Be specific in your responses.
Georgia Pacific, a manufacturer, incurs the following costs. (1) Classify each cost as either a product or a period cost. If a product cost, identify it as a prime and/or conversion cost. (2) Classify each product cost as either a direct cost or an indirect cost using the product as the cost object.
Listed here are product costs for the production of soccer balls. (1) Classify each cost (a) as either fixed or variable and (b) as either direct or indirect. (2) What pattern do you see regarding the relation between costs classified by behavior and costs classified by traceability?
Current assets for two different companies at calendar year end 2011 are listed here. One is a manufacturer, Roller Blades Mfg., and the other, Sunny Foods, is a grocery distribution company. (1) Identify which set of numbers relates to the manufacturer and which to the merchandiser. (2) Prepare the current asset section for each company from this information. Discuss why the current asset section for these two companies is different.
For each of the following accounts for a manufacturing company, place a ? in the appropriate column indicating that it appears on the balance sheet, the income statement, the manufacturing statement, and/or a detailed listing of factory overhead costs. Assume that the income statement shows the calculation of cost of goods sold and the manufacturing statement shows only the total amount of factory overhead. (An account can appear on more than one report.)
Given the following selected account balances of Randa Company, prepare its manufacturing statement for the year ended on December 31, 2011. Include a listing of the individual overhead account balances in this statement.
Customer orientation means that a company’s managers and employees respond to customers’ changing wants and needs. A manufacturer of metal parts has created a customer satisfaction survey that it asks each of its customers to complete. The survey asks about the following factors: (A) product performance;
(B) price; (C) lead time; (D) delivery. Each factor is to be rated as unsatisfactory, marginal, average, satisfactory, or very satisfied.
a. Match the competitive forces 1 through 4 to the factors on the survey. A factor can be matched to more than one competitive force.
Survey Factor
Competitive Force
A. Product performance
1. Cost
B. Price
2. Time
C. Lead time
3. Quality
D. Delivery
4. Flexibility of service
b. How can managers of this company use the information from this customer satisfaction survey to better meet competitive forces and satisfy their customers?
Following are three separate events affecting the managerial accounting systems for different companies.
Match the management concept(s) that the company is likely to adopt for the event identified. There is some overlap in the meaning of customer orientation and total quality management and, therefore, some responses can include more than one concept.
Event
Management Concept
1. The company starts measuring inventory turnover and discontinues elaborate inventory records. Its new focus is to pull inventory through the system.
a. Total quality management (TQM)
2. The company starts reporting measures on customer complaints and product returns from customers.
b. Just in time (JIT) system
3. The company starts reporting measures such as the percent of defective products and the number of units scrapped.
Listed here are the total costs associated with the 2011 production of 1,000 drum sets manufactured by Neat Beat. The drum sets sell for $300 each.
Cost by Behavior
Cost by Function
Costs
Variable
Fixed
Product
Period
1. Plastic for casing—$12,000
$12,000
$12,000
2. Wages of assembly workers—$60,000
3. Property taxes on factory—$6,000
4. Accounting staff salaries — $45,000
5. Drum stands (1,000 stands outsourced)—$25,000
6. Rent cost of equipment for sales staff—$7,000
7. Upper management salaries—$100,000
8. Annual flat fee for maintenance service—$9,000
9. Sales commissions—$10 per unit
10. Machinery depreciation—$10,000
Required
1. Classify each cost and its amount as (a) either fixed or variable and (b) either product or period. (The first cost is completed as an example.)
2. Compute the manufacturing cost per drum set.
Analysis Component
3. Assume that 1,200 drum sets are produced in the next year. What do you predict will be the total cost of plastic for the casings and the per unit cost of the plastic for the casings? Explain.
4. Assume that 1,200 drum sets are produced in the next year. What do you predict will be the total cost of property taxes and the per unit cost of the property taxes? Explain.
Assume that you are the motorcycle manufacturer’s managerial accountant. The purchasing manager asks you about preparing an estimate of the related costs for buying motorcycle seats from supplier (B). She tells you this estimate is needed because unless dollar estimates are attached to nonfinancial factors, such as lost production time, her supervisor will not give it full attention. The manager also shows you the following information.
? Production output is 3,000 motorcycles per year based on 250 production days a year.
? Production time per day is 8 hours at a cost of $2,000 per hour to run the production line.
? Lost production time due to poor quality is 1%.
? Satisfied customers purchase, on average, three motorcycles during a lifetime.
? Satisfied customers recommend the product, on average, to 10 other people.
? Marketing predicts that using seat (B) will result in 10 lost customers per year from repeat business and referrals.
? Average gross profit per motorcycle is $3,000.
Required
Estimate the costs (including opportunity costs) of buying motorcycle seats from supplier (B). This problem requires that you think creatively and make reasonable estimates; thus there could be more than one correct answer. (Hint: Reread the answer to Decision Maker and compare the cost savings for buying from supplier [B] to the sum of lost customer revenue from repeat business and referrals and the cost of lost production time.)
Shepler Boot Company makes specialty boots for the rodeo circuit. On December 31, 2010, the company had (a) 500 pairs of boots in finished goods inventory and (b) 1,500 heels at a cost of $5 each in raw materials inventory. During 2011, the company purchased 50,000 additional heels at $5 each and manufactured 20,000 pairs of boots.
Required
1. Determine the unit and dollar amounts of raw materials inventory in heels at December 31, 2011.
Analysis Component
2. Write a one half page memorandum to the production manager explaining why a just in time inventory system for heels should be considered. Include the amount of working capital that can be reduced at December 31, 2011, if the ending heel raw material inventory is cut by half.
Shown here are annual financial data at December 31, 2011, taken from two different companies.
Pinnacle Retail
Slope Board Manufacturing
Beginning inventory
Merchandise
$150,000
Finished goods
$300,000
Cost of purchases
250,000
Cost of goods manufactured
586,000
Ending inventory
Merchandise
100,000
Finished goods
200,000
Required
1. Compute the cost of goods sold section of the income statement at December 31, 2011, for each company.
Include the proper title and format in the solution.
2. Write a half page memorandum to your instructor (a) identifying the inventory accounts and (b) describing where each is reported on the income statement and balance sheet for both companies.
Many fast food restaurants compete on lean business concepts. Match each of the following activities at a fast food restaurant with the lean business concept it strives to achieve. Some activities might relate to more than one lean business concept.
The following calendar year end information is taken from the December 31, 2011, adjusted trial balance and other records of Plaza Company.
Advertising expense
$ 30,750
Direct labor
$ 677,480
Depreciation expense — Office equipment
9,250
Income taxes expense
235,725
Depreciation expense — Selling equipment
10,600
Indirect labor
58,875
Depreciation expense — Factory equipment
35,550
Miscellaneous production costs
10,425
Factory supervision
104,600
Office salaries expense
65,000
Factory supplies used
9,350
Raw materials purchases
927,000
Factory utilities
35,000
Rent expense — Office space
24,000
Inventories
Rent expense — Selling space
28,100
Raw materials, December 31, 2010
168,850
Rent expense — Factory building
78,800
Raw materials, December 31, 2011
184,000
Maintenance expense — Factory equipment
37,400
Goods in process, December 31, 2010
17,700
Sales
4,527,000
Goods in process, December 31, 2011
21,380
Sales discounts
64,500
Finished goods, December 31, 2010
169,350
Sales salaries expense
394,560
Finished goods, December 31, 2011
138,490
Required
1. Prepare the company’s 2011 manufacturing statement.
2. Prepare the company’s 2011 income statement that reports separate categories for (a) selling expenses and (b) general and administrative expenses.
Analysis Component
3. Compute the (a) inventory turnover, defined as cost of goods sold divided by average inventory, and
(b) days’ sales in inventory, defined as 365 times ending inventory divided by cost of goods sold, for both its raw materials inventory and its finished goods inventory. (To compute turnover and days’ sales in inventory for raw materials, use raw materials used rather than cost of goods sold.) Discuss some possible reasons for differences between these ratios for the two types of inventories. Round answers to one decimal place.
Listed here are the total costs associated with the 2011 production of 10,000 Blu ray Discs (BDs) manufactured by Hip Hop. The BDs sell for $15 each.
Cost by Behavior
Cost by Function
Costs
Variable
Fixed
Product
Period
1. Plastic for BDs — $1,000
$1,000
$1,000
2. Wages of assembly workers — $20,000
3. Cost of factory rent — $4,500
4. Systems staff salaries — $10,000
5. Labeling (outsourced)—$2,500
6. Cost of office equipment rent—$700
7. Upper management salaries—$100,000
8. Annual fixed fee for cleaning service—$3,000
9. Sales commissions—$0.50 per BD
10. Machinery depreciation—$15,000
Required
1. Classify each cost and its amount as (a) either fixed or variable and (b) either product or period. (The first cost is completed as an example.)
2. Compute the manufacturing cost per BD.
Analysis Component
3. Assume that 15,000 BDs are produced in the next year. What do you predict will be the total cost of plastic for the BDs and the per unit cost of the plastic for the BDs? Explain.
4. Assume that 15,000 BDs are produced in the next year. What do you predict will be the total cost of factory rent and the per unit cost of the factory rent? Explain.
Purchase Manager, in this chapter. Assume that you are the motorcycle manufacturer’s managerial accountant. The purchasing manager asks you about preparing an estimate of the related costs for buying motorcycle seats from supplier (B). She tells you this estimate is needed because unless dollar estimates are attached to nonfinancial factors such as lost production time, her supervisor will not give it full attention. The manager also shows you the following information.
Production output is 2,000 motorcycles per year based on 250 production days a year.
Production time per day is 8 hours at a cost of $500 per hour to run the production line.
Lost production time due to poor quality is 1%.
Satisfied customers purchase, on average, three motorcycles during a lifetime.
Satisfied customers recommend the product, on average, to 10 other people.
Marketing predicts that using seat (B) will result in 8 lost customers per year from repeat business and referrals.
Average gross profit per motorcycle is $4,000.
Required
Estimate the costs (including opportunity costs) of buying motorcycle seats from supplier (B). This problem requires that you think creatively and make reasonable estimates; thus there could be more than one correct answer.
The headquarters of Hill Crest Corporation, a private company with $15.5 million in annual sales, is located in California. Hill Crest provides for its 150 clients an online legal software service that includes data storage and administrative activities for law offices. The company has grown rapidly since its inception 3 years ago, and its data processing department has expanded to accommodate this growth. Because Hill Crest’s president and sales personnel spend a great deal of time out of the office soliciting new clients, the planning of the IT facilities has been left to the data processing professionals. Hill Crest recently moved its headquarters into a remodeled warehouse on the outskirts of the city. While remodeling the warehouse, the architects retained much of the original structure, including the wooden shingled exterior and exposed wooden beams throughout the interior. The minicomputer distributive processing hardware is situated in a large open area with high ceilings and skylights. The openness makes the data processing area accessible to the rest of the staff and encourages a team approach to problem solving. Before occupying the new facility, city inspectors declared the building safe; that is, it had adequate fire extinguishers, sufficient exits, and so on. In an effort to provide further protection for its large database of client information, Hill Crest instituted a tape backup procedure that automatically backs up the database every Sunday evening, avoiding interruption in the daily operations and procedures. All tapes are then labeled and carefully stored on shelves reserved for this purpose in the data processing department. The departmental operator’s manual has instructions on how to use these tapes to restore the database, should the need arise. A list of home phone numbers of the individuals in the data processing department is available in case of an emergency. Hill Crest has recently increased its liability insurance for data loss from $50,000 to $100,000. This past Saturday, the Hill Crest headquarters building was completely ruined by fire, and the company must now inform its clients that all of their information has been destroyed.
Required
a. Describe the computer security weaknesses present at Hill Crest Corporation that made it possible for a disastrous data loss.
b. List the components that should have been included in the disaster recovery plan at Hill Crest Corporation to ensure computer recovery within 72 hours.
c. What factors, other than those included in the plan itself, should a company consider when formulating a disaster recovery plan?
Micro Systems, a developer of database software packages, is a publicly held company and listed with the SEC. The company has no internal audit function. In complying with SOX, Micro Systems has agreed to establish an internal audit function and strengthen its audit committee to include all outside directors. Micro Systems has held its initial planning meeting to discuss the roles of the various participants in the internal control and financial reporting process. Participants at the meeting included the company president, the chief financial officer, a member of the audit committee, a partner from Micro Dynamics’ external audit firm, and the newly appointed manager of the internal audit department. Comments from the various meeting participants are presented below. President: We want to ensure that Micro Systems complies with SOX. The internal audit department should help to strengthen our internal control system by correcting problems. I would like your thoughts on the proper reporting relationship for the manager of the internal audit department. CFO: I think the manager of the internal audit department should report to me because much of the department’s work is related to financial issues. The audit committee should have oversight responsibilities. Audit committee member: I believe we should think through our roles more carefully. The Tread way Commission has recommended that the audit committee play a more important role in the financial reporting process; the duties of today’s audit committee have expanded beyond mere rubber stamp approval. We need to have greater assurance that controls are in place and being followed. External audit firm partner: We need a close working relationship among all of our roles. The internal audit department can play a significant role in monitoring the control systems on a continuing basis and should have strong ties to your external audit firm. Internal audit department manager: The internal audit department should be more involved in operational auditing, but it also should play a significant monitoring role in the financial reporting area.
Required
a. Describe the role of each of the following in the establishment, maintenance, and evaluation of Micro Systems’ internal control.
Management
Audit committee
External auditor
Internal audit department
b. Describe the responsibilities that Micro Systems’ audit committee has in the financial reporting process.
1. Which of the following is NOT a data communications control objective?
a. maintaining the critical application list
b. correcting message loss due to equipment failure
c. preventing illegal access
d. rendering useless any data that a perpetrator successfully captures
2. Reviewing database authority tables is a(n)
a. access control.
b. organizational structure control.
c. data resource control.
d. operating resource control.
3. Hackers can disguise their message packets to look as if they came from an authorized user and gain access to the host’s network using a technique called
a. spoofing.
b. spooling.
c. dual homed.
d. screening.
4. Transmitting numerous SYN packets to a targeted receiver, but NOT responding to an ACK, is
Stephanie Baskill, an unemployed accounting clerk, lives one block from Cleaver Manufacturing Company. While walking her dog last year, she noticed some ERP manuals in the dumpsters. Curious, she took the manuals home with her. She found that the documentation in the manual was dated 2 months previous, so she thought that the information must be fairly current. Over the next month, Stephanie continued to collect all types of manuals from the dumpster during her dog walking excursions. Cleaver Manufacturing Company was apparently updating all of its documentation manuals and placing them online. Eventually, Stephanie found manuals about critical inventory reorder formulas, the billing system, the sales order system, the payables system, and the operating system. Stephanie went to the local library and read as much as she could about this particular operating system. To gain access to the organization, she took a low profile position as a cleaning woman, giving her access to all areas in the building. While working, Stephanie snooped through offices, watched people who were working late type in their passwords, and guessed passwords. She ultimately printed out lists of user IDs and passwords using a Trojan horse virus, thus obtaining all the necessary passwords to set herself up as a supplier, customer, systems operator, and systems librarian. As a customer, she ordered enough goods to trigger the automatic inventory procurement system to purchase more raw materials. Then, as a supplier, Stephanie would deliver the goods at the specified price. She then adjusted the transaction logs once the bills were paid to cover her tracks. Stephanie was able to embezzle, on average, $125,000 a month. About 16 months after she began working at Cleaver, the controller saw her at a very expensive French restaurant one evening, driving a Jaguar. He told the internal auditors to keep a close watch on her, and they were able to catch her in the act.
Required
a. What weaknesses in the organization’s control structure must have existed to permit this type of embezzlement?
b. What specific control techniques and procedures could have helped prevent or detect this fraud?
A global manufacturing company has over 100 subsidiaries worldwide reporting to it each month. The reporting units prepare the basic financial statements and other key financial data on prescribed forms, which are e mailed or faxed to the corporate headquarters. The financial data are then entered into the corporate database from which consolidated statements are prepared for internal planning and decision making. Current reporting policy requires that the subsidiaries provide the previous month’s reports by the tenth working day of each new month. Accounting department staff log and enter the reports into the database. Approximately 15 percent of the reporting units are delinquent in submitting their reports, and 3 to 4 days are required to enter all the data into the database. After the data are loaded into the system, data verification programs are run to check footings, cross statement consistency, and dollar range limits. Any errors in the data are traced and corrected, and reporting units are notified of all errors via e mail. The company has decided to upgrade its computer communications network with a new system that will support more timely receipt of data at corporate headquarters. The systems department at corporate headquarters is responsible for the overall design and implementation of the new system. It will use current computer communications technology and install LANs, PCs, and servers at all reporting units. The new system will allow clerks at the remote sites to send financial data to the corporate office via the Internet. The required form templates will be downloaded to the remote sites along with the data verification programs. The clerks will enter data into the forms to create a temporary file, which data verification programs will check for errors. All corrections can thus be made before transmitting the data to headquarters. The data would be either transmitted to corporate headquarters immediately or the corporate headquarters computer would retrieve it from disk storage at the remote site as needed. Data used at corporate headquarters would therefore be free from errors and ready for consolidation. The company’s controller is pleased with the prospects of the new system, which should shorten the reporting period by 3 days. He is, however, concerned about security and data integrity during the transmission. He has scheduled a meeting with key personnel from the systems department to discuss these concerns. Required
The company could experience data security and integrity problems when transmitting data between the reporting units and corporate headquarters.
a. Identify and explain the data security and integrity problems that could occur.
b. For each problem identified, describe a control procedure that could be employed to minimize or eliminate the problem. Use the following format to present your answer.
Listed here are five scenarios. For each scenario, discuss the possible damages that can occur. Suggest a preventive control.
a. An intruder taps into a telecommunications device and retrieves the identifying codes and personal identification numbers for ATM cardholders. (The user subsequently codes this information onto a magnetic coding device and places this strip on a piece of cardboard.)
b. Because of occasional noise on a transmission line, electronic messages received are extremely garbled.
c. Because of occasional noise on a transmission line, data being transferred is lost or garbled.
d. An intruder is temporarily delaying important strategic messages over the telecommunications lines.
e. An intruder is altering electronic messages before the user receives them.
Listed here are five scenarios. For each scenario, discuss the potential consequences and give a prevention technique.
a. The systems operator opened a bag of burned microwave popcorn directly under a smoke detector in the computing room where two mainframes, three high speed printers, and approximately 40 tapes are housed. The extremely sensitive smoke detector triggered the sprinkler system. Three minutes passed before the sprinklers could be turned off.
b. A system programmer intentionally placed an error into a program that causes the operating system to fail and dump certain confidential information to disks and printers.
c. Jane’s employer told her she would be laid off in 3 weeks. After 2 weeks, Jane realized that finding another secretarial job was going to be very tough. She became bitter. Her son told her about a virus that had infected his school’s computers and that one of his disks had been infected. Jane took the infected disk to work and copied it onto the network server, which is connected to the company’s mainframe. One month later, the company realized that some data and application programs had been destroyed.
d. Robert discovered a new sensitivity analysis public domain program on the Internet. He downloaded the software to his microcomputer at home, then took the application to work and placed it onto his networked personal computer. The program had a virus on it that eventually spread to the company’s mainframe.
e. Murray, a trusted employee and a systems engineer, had access to both the computer access control list and user passwords. The firm’s competitor recently hired him for twice his salary. After leaving, Murray continued to browse through his old employer’s data, such as price lists, customer lists, bids on jobs, and so on. He passed this information on to his new employer.
Brew Bottle Company (BBC) is in the process of planning a more advanced computer based information system. Slavish & Moore, LLP, BBC’s consulting firm, have recently been provided with an overview of their proposed plan: The Brew Bottle Company Information System (BBCIS) will be created with the help of its employees so that the system will function effectively. This helps ensure that the end product will perform the tasks that the user wants. System construction will begin with prototyping, computer aided software engineering (CASE) technology, and Gantt charts. From here, systems professionals and a systems administrator who will work fulltime for BBC will create data models of the business process, define conceptual user views, design database tables, and specify system controls. Each user in each department will submit a written description of his or her needs and business problems to the systems professionals. Systems professionals will then perform analysis of feasibility and system design. Each aspect of the system will be properly documented for control reasons; this will help if problems arise in the future stages of development and is essential to long term system success. The new systems administrator will determine access privileges, maintain the access control list, and maintain the database authorization table. Anyone requesting access will fill out a petition, which the systems administrator must approve and sign. The administrator will have sole access to the transaction log, which will be used to record all changes made to a file or database. This information will help detect unauthorized access, reconstruct events if needed, and promote personal accountability. The systems administrator will also be responsible for updating virus protection weekly so that viruses planted intentionally or accidentally will not damage the system. One of the most important tasks of the systems administrator will be to copy databases and system documentation for critical applications to tape or disk on a daily basis. These disks and tapes will be stored in a secure location away from the company property. Employees requiring computer access will be given a user name and password that will be entered when logging on to their computer terminal. A dialog box will appear when the system is turned on and this information will be entered. Correct entry of information will give the user access; if information is entered incorrectly, the user will not be granted access. Furthermore, if a computer terminal is left idle for more than 5 minutes, a password will be needed to regain access. For security reasons, users will be required to change their passwords once every year. Hardware will be purchased from Bell Computer Company with the advice of in house systems developers. With the exception of basic applications, user departments will purchase computer software, which will be added to the system. BBCIS will run off of a computing center located in the company’s administration building adjacent to the factory. Access to the computing center will require formal authorization. When entering the room, there will be two security guards. Authorized employees will need to swipe their ID cards to pass though security. Times will be recorded when employees swipe their cards for entrance and exit. The actual room that houses the computer systems will have an advanced air conditioning and air filtration system to eliminate dust and pollens. There will also be a sprinkler system to minimize damages in case of a fire.
Required
Based on BBC’s plans for the implementation of a new computer system, describe the potential risks and needed controls. Classify these according to the relevant areas of the COSO framework.
1. The controls in a computerized system are classified as
a. input, processing, and output.
b. input, processing, output, and storage.
c. input, processing, output, and control.
d. input, processing, output, storage, and control.
e. collecting, sorting, summarizing, and reporting.
2. An employee in the receiving department keyed in a shipment from a remote terminal and inadvertently omitted the purchase order number. The best systems control to detect this error would be a
a. batch total.
b. completeness test.
c. sequence check.
d. reasonableness test.
e. compatibility test.
3. In an automated payroll processing environment, a department manager substituted the time card for a terminated employee with a time card for a fictitious employee. The fictitious employee had the same pay rate and hours worked as the terminated employee. The best control technique to detect this action using employee identification numbers would be a
a. batch total.
b. record count.
c. hash total.
d. subsequent check.
e. financial total.
4. SOX legislation calls for sound internal control practices over financial reporting and requires SEC registered corporations to maintain systems of internal control that meet SOX standards. An integral part of internal control is the appropriate use of preventive controls. Which of the following is not an essential element of preventive control?
a. separation of responsibilities for the recording, custodial, and authorization functions
b. sound personnel practices
c. documentation of policies and procedures
d. implementation of state of the art software and hardware
e. physical protection of assets
5. Which of the following is NOT a test for identifying application errors?
A catalog company has hired you to computerize its sales order entry forms. Approximately 60 percent of all orders are received over the telephone, with the remainder received by either mail or fax. The company wants the phone orders to be input as they are received. The mail and fax orders can be batched together in groups of 50 and submitted for keypunching as they become ready. The following information is collected for each order:
Customer number (if customer does not have one, one needs to be assigned)
Customer name
Address
Payment method (credit card or money order)
Credit card number and expiration date (if necessary)
Items ordered and quantity
Unit price
Required
Determine control techniques to make sure that all orders are entered accurately into the system. Also, discuss any differences in control measures between the batch and the real time processing.
Two years ago, an external auditing firm supervised the programming of embedded audit modules for Previts Office Equipment Company. During the audit process this year, the external auditors requested that a transaction log of all transactions be copied to the audit file. The external auditors noticed large gaps in dates and times for transactions being copied to the audit file. When they inquired about this, they were informed that increased processing of transactions had been burdening the mainframe system and that operators frequently had to turn off the EAM to allow the processing of important transactions in a timely fashion. In addition, much maintenance had been performed during the past year on the application programs.
Required
Outline any potential exposures and determine the courses of action the external auditors should use to proceed.
Avatar Financials, Inc., located on Madison Avenue in New York City, is a company that provides financial advice to individuals and small to mid sized businesses. Its primary operations are in wealth management and financial advice. Each client has an account where basic personal information is stored at a server within the main office in New York City. The company also keeps the information about the amount of investment of each client on a separate server at their data center in Bethlehem, Pennsylvania. This information includes the total value of the portfolio, type of investments made, the income structure of each client, and associated tax liabilities. Avatar decided to purchase software for asset management from specialized vendors. This software allows them to run analytics on the portfolios and run detailed simulations of market trends and is called Siman (SIMulation ANalytics). V Dot Solutions, another contractual company that is customizing and installing Siman, has sent a team of six systems analysts to carry out this task. They anticipate additional hardware installations to run the simulation analytics on Siman. V Dot’s setup requires them to train two people from Avatar who will be responsible for minor issues and basic maintenance of the system. Special consultants from V Dot will deal with major problems and issues. It takes 4 weeks to completely have the system operational and integrated into Avatar’s existing computer system. The testing phase of the project has been readjusted to allow the two employees of Avatar to run these tests and ensure compatibility. A year after the installation of the simulation software Siman, Avatar finds it very useful. To upgrade the systems to the next level, they decide to go to another data source company for a raw market data feed that will be used to run the simulations. However, this requires changes to the source code of Siman. Fortunately, within its analytics department that uses Siman, Avatar has two programmers who are well versed in the programming language that Siman was written in. These programmers are able to implement the changes that will allow Siman II to use the new data feed. To remain competitive, Avatar has placed the programmers under a tight time constraint. To expedite the process, the documentation process is shortened with the intention that it will be looked into once the systems are running. The programmers also will be deployed back to the maintenance operations once the project is complete. The contract with Siman’s original vendor, V Dot, has expired and the company does not want to extend their maintenance services for another year. Instead, it believes that these two programmers will be able to perform the same tasks for less money. Required
a. Discuss the major internal control issues in Avatar’s systems development approach.
b. Comment on the duties the two programmers of Avatar perform. Are systems maintenance and program development extensions of the same responsibility?
c. Identify potential issues that might arise due to weak internal controls.
The Balcar Company’s auditors are developing an audit plan to review the company’s systems development procedures. Their audit objectives are to ensure that
1. the system was judged necessary and justified at various checkpoints throughout the SDLC.
2. systems development activities are applied consistently and in accordance with management’s policies to all systems development projects.
3. the system as originally implemented was free from material errors and fraud.
4. system documentation is sufficiently accurate and complete to facilitate audit and maintenance activities.
The following six controllable activities have been identified as sources of audit evidence for meeting these objectives: systems authorization, user specification, technical design, internal audit participation, program testing, and user testing and acceptance.
Required
a. Explain the importance of each of the six activities in promoting effective control.
b. Outline the tests of controls that the auditor would perform in meeting audit objectives.
payroll coordinator, George Jones, an authorization form in order to add an employee to the payroll. After Jones enters this information into the system, the computer automatically determines the overtime and shift differential rates for the individual, updating the payroll master files.
week’s time cards and begins the computerized processing of payroll information to produce paychecks the following Friday. Jones then reviews the time cards to ensure that the hours worked are correctly totaled; the system determines overtime and/or any shift differential.
to each payroll check produced. The check stocks are stored in a box next to the computer printer to provide immediate access. After the checks are printed, an automatic check signing machine signs them with an authorized signature plate that Jones keeps locked in a safe.
second and third shift employees with the appropriate shift supervisor. Jones then notifies the data processing department that he is finished with his weekly processing, and data processing makes a backup of the payroll master for storage in the computer room. Required
Identify and describe:
a. Areas in the payroll processing system where the internal controls are inadequate.
b. Two areas in the payroll system where the system controls are satisfactory.
A manufacturing company’s balance sheet and income statement differ from those for a merchandising or service company.
Required
1. Fill in the [BLANK] descriptors on the partial balance sheets for both the manufacturing company and the merchandising company. Explain why a different presentation is required.
Manufacturing Company
ADIDAS GROUP Partial Balance Sheet December 31, 2011
Current assets
Cash
$10,000
[BLANK]
8,000
[BLANK]
5,000
[BLANK]
7,000
Supplies
500
Prepaid insurance
500
Total current assets
$31,000
Merchandising Company
PAYLESS SHOE OUTLET Partial Balance Sheet December 31, 2011
Current assets
Cash
$ 5,000
BLANK]
12,000
Supplies
500
Prepaid insurance
500
Total current assets
$18,000
2. Fill in the [BLANK] descriptors on the income statements for the manufacturing company and the merchandising company. Explain why a different presentation is required.
Manufacturing Company
ADIDAS GROUP Partial Income Statement For Year Ended December 31, 2011
Sales
$200,000
Cost of goods sold
Finished goods inventory, Dec. 31, 2010
10,000
[BLANK]
120,000
Goods available for sale
130,000
Finished goods inventory, Dec. 31, 2011
(7,000)
Cost of goods sold
123,000
Gross profit
$ 77,000
Merchandising Company
PAYLESS SHOE OUTLET Partial Income Statement For Year Ended December 31, 2011
Sales
$190,000
Cost of goods sold
Merchandise inventory, Dec. 31, 2010
8,000
[BLANK]
108,000
Goods available for sale
116,000
Merchandise inventory, Dec. 31, 2011
(12,000)
Cost of goods sold
104,000
Gross profit
$ 86,000
3. A manufacturer’s cost of goods manufactured is the sum of (a) _______, (b) _______, and (c) _______ costs incurred in producing the product.
The following account balances and other information are from SUNN Corporation’s accounting records for year end December 31, 2011. Use this information to prepare (1) a table listing factory overhead costs, (2) a manufacturing statement (show only the total factory overhead cost), and (3) an income statement.
Advertising expense
$ 85,000
Goods in process inventory, Dec. 31, 2010
$ 8,000
Amortization expense — Factory Patents
16,000
Goods in process inventory, Dec. 31, 2011
9,000
Bad debts expense
28,000
Income taxes
53,400
Depreciation expense — Office equipment
37,000
Indirect labor
26,000
Depreciation expense — Factory building
133,000
Interest expense
25,000
Depreciation expense — Factory equipment
78,000
Miscellaneous expense
55,000
Direct labor
250,000
Property taxes on factory equipment
14,000
Factory insurance expired
62,000
Raw materials inventory, Dec. 31, 2010
60,000
Factory supervision
74,000
Raw materials inventory, Dec. 31, 2011
78,000
Factory supplies used
21,000
Raw materials purchases
313,000
Factory utilities
115,000
Repairs expense — Factory equipment
31,000
Finished goods inventory, Dec. 31, 2010
15,000
Salaries expense
150,000
Finished goods inventory, Dec. 31, 2011
12,500
Sales
1,630,000
Analyze the account balances and select those that are part of factory overhead costs.
Arrange these costs in a table that lists factory overhead costs for the year.
Analyze the remaining costs and select those related to production activity for the year; selected costs should include the materials and goods in process inventories and direct labor.
Prepare a manufacturing statement for the year showing the calculation of the cost of materials used in production, the cost of direct labor, and the total factory overhead cost. When presenting overhead cost on this statement, report only total overhead cost from the table of overhead costs for the year. Show the costs of beginning and ending goods in process inventory to determine cost of goods manufactured.
Organize the remaining revenue and expense items into the income statement for the year. Combine cost of goods manufactured from the manufacturing statement with the finished goods inventory amounts to compute cost of goods sold for the year.
e. Is applicable only in manufacturing businesses.
2. A direct cost is one that is
a. Variable with respect to the cost object.
b. Traceable to the cost object.
c. Fixed with respect to the cost object.
d. Allocated to the cost object.
e. A period cost.
3. Costs that are incurred as part of the manufacturing process, but are not clearly traceable to the specific unit of product or batches of product, are called
a. Period costs.
b. Factory overhead.
c. Sunk costs.
d. Opportunity costs.
e. Fixed costs.
4. The three major cost components of manufacturing a product are
a. Direct materials, direct labor, and factory overhead.
b. Period costs, product costs, and sunk costs.
c. Indirect labor, indirect materials, and fixed expenses.
d. Variable costs, fixed costs, and period costs.
e. Opportunity costs, sunk costs, and direct costs.
5. A company reports the following for the current year.
Finished goods inventory, beginning year
$6,000
Finished goods inventory, ending year
3,200
Cost of goods sold
7,500
Its cost of goods manufactured for the current year is
Ethical Issues Surrounding Activity Based Costing*
Xavier Auto Parts, Inc. manufactures a wide range of auto parts, which it sells to auto manufacturers, primarily in the United States and Canada.* The company’s Engine Parts Division operated three plants in South Carolina and specialized in engine parts. The division’s Charlotte plant manufactured some 6,500 different parts.
Trouble Brewing
Both the Engine Parts Division, as well as the Charlotte plant in particular, had shown satisfactory profitability for the past 20 years. In 2009, however, the Charlotte plant’s profitability took a sharp downward turn, in spite of rising sales. The trend continued through the next several years. Management at both the division and plant levels took note of the plant’s declining profits and held several strategy meetings as a result.
Division Strategy
The Engine Parts Division had always positioned itself as the industry’s full line producer. If a customer wanted a product, the division would make it. Although occasionally very low volume products were discontinued due to lack of consistent orders, the division’s product line remained a full line of engine parts. As part of its strategy review, division management did two things. First, an activity based costing study was initiated in the Charlotte plant in order to give management a better picture of each product line’s profitability. Second, a high level review was undertaken to determine whether the full line producer strategy continued to make sense.
Activity based Costing
An ABC project team was formed, and a successful pilot study was conducted on two of the Charlotte plant’s product lines. Then the ABC project was extended to the entire Charlotte operation. Management was astonished to find that fully a quarter of the plant’s products were selling at a loss. Moreover, the ABC project highlighted the extent of the product line proliferation at the Charlotte plant. It turned out that in many instances, unprofitable products had been dropped only to creep back into the product line up after a customer requested it and a salesperson acquiesced. It became a joke around the plant that the only way to be sure a dropped product was really gone was to burn the engineering drawings and destroy the special tools required to make it.
ABC Team Recommendations
The ABC project team made sweeping recommendations to division management, which suggested that the Charlotte plant’s product lines be pruned and that roughly 20 percent of its products be dropped. New emphasis would then be devoted to increasing the profitability of the remaining 80 percent of the Charlotte plant’s products. Attention would be given to identifying inefficient processes, and process improvements would be evaluated.
Top Management Response
Top management balked at the recommendations of the ABC project team. Some top managers did not believe the ABC results. It just seemed impossible to them that so many of the Charlotte plant’s products were losers. Other members of the management team largely accepted the validity of the ABC study, but they, too, hesitated to drop so many products. To do so would most likely have meant massive layoffs and even the possibility of closing the Charlotte plant altogether, while shifting its remaining production to the division’s other two plants. Some members of the ABC project team quietly speculated that some of the division’s managers were more concerned about their own pay and perks than they were about the well being of the division. In the final analysis, only a handful of products were dropped, and then only if they were suspected to be unprofitable before the ABC study was undertaken.
Aftermath
The Charlotte plant’s profits continued to deteriorate, as did the Engine Parts Division’s profitability. Eventually, Xavier’s corporate management cut its losses by selling off the Engine Parts Division to a competitor at bargain basement prices. The division’s new owners closed the Charlotte plant and changed the division’s focus to be a boutique producer of high quality engine parts, which was more in line with its own corporate strategy.
Ethical Issues
What ethical issues do you see in this scenario? How would you resolve them?
In one page please answer the following questions.
(1) Question: What ethical issues do you see in this scenario? How would you resolve them?
(2) What do you think is going on here? How would you evaluate the company’s year 2 performance? Using variable costing, what would operating income be for year 1? For year 2? (Assume that all selling and administrative costs are committed and unchanged.) Compare those results with the absorption costing statements. Comment on the ethical issues in this scenario.
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Question (1) Ethical Issues Surrounding Activity Based Costing* Xavier Auto Parts, Inc. manufactures a wide range of auto parts, which it sells to auto manufacturers, primarily in the United States and Canada.* The company’s Engine Parts Division operated three plants in South Carolina and specialized in engine parts. The division’s Charlotte plant manufactured some 6,500 different parts. Trouble Brewing Both the Engine Parts Division, as well as the Charlotte plant in particular, had shown satisfactory profitability for the past 20 years. In 2009, however, the Charlotte plant’s profitability took a sharp downward turn, in spite of rising sales. The trend continued through the next several years. Management at both the division and plant levels took note of the plant’s declining profits and held several strategy meetings as a result. Division Strategy The Engine Parts Division had always positioned itself as the industry’s full line producer. If a customer wanted a product, the division would make it. Although occasionally very low volume products were discontinued due to lack of consistent orders, the division’s product line remained a full line of engine parts. As part of its strategy review, division management did two things. First, an activity based costing study was initiated in the Charlotte plant in order to give management a better picture of each product line’s profitability. Second, a high level review was undertaken to determine whether the full line producer strategy continued to make sense. Activity based Costing An ABC project team was formed, and a successful pilot study was conducted on two of the Charlotte plant’s product lines. Then the ABC project was extended to the entire Charlotte operation. Management was astonished to find that fully a quarter of the plant’s products were selling at a loss. Moreover, the ABC project highlighted the extent of the product line proliferation at the Charlotte plant. It turned out that in many instances,…
Student ID: 21794894 Exam: 061690RR ACCOUNTING FOR MERCHANDISING When you have completed your exam and reviewed your answers, click Submit Exam. Answers will not be recorded until you hit Submit Exam. If you need to exit before completing the exam, click Cancel Exam. Questions 1 to 20: Select the best answer to each question. Note that a question and its answers may be split across a page break, so be sure that you have seen the entire question and all the answers before choosing an answer. 1. Goods available for sale are $350,000; beginning inventory is $24,000; ending inventory is $32,000; and cost of goods sold is $275,000. The inventory turnover is A. 9.82. B. 12.50. C. 8.59. D. 11.46. 2. Committing a fraud because the employee feels that it will be easy to do is indicative of which part of the fraud triangle? A. Perceived pressure B. Perceived opportunity C. Rationalization D. Realization 3. A company has $8,200 in net sales, $1,100 in gross profit, $2,500 in ending inventory, and $2,000 in beginning inventory. The company’s cost of goods sold is A. $7,100. B. $6,200. C. $5,600. D. $5,700. 4. Goods available for sale are $118,000; beginning inventory is $37,000; ending inventory is $42,000; and cost of goods sold is $77,000. The inventory turnover is A. 2.99. B. 1.83. C. 1.95. D. 1.53. 5. Committing a fraud because the employee feels “I deserve a pay raise. The company owes this to me” is indicative of which part of the fraud triangle? A. Realization B. Perceived opportunity C. Perceived pressure D. Rationalization 6. Which of the following would probably not cause inventory shrinkage? A. Employee theft B. Spoilage of items C. Spills of items D. Correct counting of all inventory 7. One of the biggest factors in implementing SOX was A. disclosing deficiencies in internal controls. B. reviewing the financial reports. C. the cost of implementing the system. D. establishing internal control procedures. 8. When a merchandiser sells on account, which of the following is not needed to record the transaction? A. Inventory B. Cash C. Cost of goods sold D. Accounts receivable 9. New technology, like the latest cell phones and HDTV, would probably be costed using the A. moving average method of inventory costing. B. FIFO method of inventory costing. C. specific identification method of inventory costing. D. LIFO method of inventory costing. 10. Meranda Company reports the following inventory information: What is the total value of the merchandise under LCM (lower of cost or market)? Inventory Number Inventory Quantity Unit Cost Unit Market Value APD 3838 325 $56.78 $55.32 CPZ 1212 506 $92.31 $92.78 IXL 4039 817 $77.89 $79.31 EOD 3902 382 $19.38 $19.02 DKS 4823 626 $33.46 $30.74 A. $158,545.60 B. $157,147.60 C. $154,832.90 D. $156,230.80 11. A company’s current ratio increased from 1.23 to 1.45. What does this mean? A. There isn’t enough information to explain the increase. B. This means that current assets increased and current liabilities increased. C. This means that current assets decreased and current liabilities decreased. D. This means that current assets increased and current liabilities decreased. 12. A low gross profit percentage means that A. the cost of goods sold was relatively high. B. general and administrative expenses are very high. C. the cost of goods sold was relatively low. D. selling expenses are very low. 13. If current assets decrease and current liabilities increase, the current ratio A. will change based on the change in total assets. B. remains the same. C. increases. D. decreases. 14. Casey Company’s beginning inventory and purchases during the fiscal year ended December 31, 2012, were as follows: (Note: The company uses a perpetual system of inventory.) What is the cost of goods sold for Casey Company for 2012 using LIFO? Units Unit Price Total Cost January 1—Beginning Inventory 20 $12 $240 March 8—Sold 14 April 2—Purchase 30 $13 $390 June 5—Sold 25 Aug 6—Purchase 25 $14 $350 Sept 11—Sold 22 Total Cost of Inventory $980 Ending inventory is 14 units. A. $264 B. $801 C. $784 D. $308 15. Isaiah Sporting Goods uses the perpetual average cost method of determining inventory costs. Below is the inventory record for Product C124: Date Received Sold Cost/Unit Balance April 22 534 $6.58 $3,513.72 May 17 433 $6.70 $2,901.10 June 21 389 $6.76 $2,629.64 August 2 436 $6.44 $2,807.84 What is the average cost per unit after the receipt of the May 17 inventory (rounded to the nearest cent)? A. $6.00 B. $6.55 C. $6.63 D. $7.40 16. Nick Company reports the following inventory information: What is the total value of the merchandise under LCM (lower of cost or market)? Inventory Number Inventory Quantity Unit Cost Unit Market Value APD 4837 440 $51.29 $51.48 CPZ 2837 290 $76.59 $77.02 IXL 9291 310 $42.34 $42.47 EOD 1717 200 $22.19 $21.75 DKS 3088 180 $31.22 $31.17 A. $67,961.70 B. $68,210.30 C. $67,864.70 D. $68,113.30 17. Net sales times the historical gross profit percentage yields the estimated A. beginning inventory. B. gross profit. C. ending inventory. D. cost of goods sold. 18. A company’s gross profit percentage decreases from 58% to 51%. What does this mean? A. We can’t determine anything definite from the information given. B. This means that net income will be lower. C. This means that there will be a net loss. D. This means that net income will be higher. 19. Under Sarbanes Oxley, those officers signing off on the reports must have evaluated the company’s internal control within the previous A. nine months. B. six months. C. year. D. 90 days. 20. A drawback to using _______ when inventory costs are rising is that the company reports lower net income. End of exam A. LIFO B. specific identification costing C. average costing D. FIFO
The staff of Porter Manufacturing has estimated the following net after tax cash flows and probabilities for a new manufacturing process:
Net After Tax Cash Flows
Year
P _ 0.2
P _ 0.6
P _ 0.2
0
($100,000)
($100,000)
($100,000)
1
20,000
30,000
40,000
22
0,000
30,000
40,000
3
20,000
30,000
40,000
4
20,000
30,000
40,000
5
20,000
30,000
40,000
5*
0
20,000
30,000
Line 0 gives the cost of the process, Lines 1 through 5 give operating cash flows, and Line 5* contains the estimated salvage values. Porter”s cost of capital for an average risk project is 10 percent.
a. Assume that the project has average risk. Find the project”s expected NPV. (Hint: Use expected values for the net cash flow in each year.)
b. Find the best case and worst case NPVs. What is the probability of occurrence of the worst case if the cash flows are perfectly dependent (perfectly positively correlated) over time? If they are independent over time?
c. Assume that all the cash flows are perfectly positively correlated, that is, there are only three possible cash flow streams over time: (1) the worst case, (2) the most likely, or base, case, and (3) the best case, with probabilities of 0.2, 0.6, and 0.2, respectively. These cases are represented by each of the columns in the table. Find the expected NPV, its standard deviation, and its coefficient of variation.
Zimrod (Pty) Ltd (‘Zimrod’) supplies corporate clothing and gifts to a diversified customer base in South Africa. Zimrod’s head office is based in Midrand, Gauteng. This 4 500 m² facility houses the company’s main warehouse and the procurement and administrative divisions, together with an impressive showroom. Zimrod also has branches in Cape Town, Durban and Port Elizabeth, which service customers in those regions.
Zimrod imports clothing from various suppliers based in India, China and Taiwan. The clothing range includes T shirts, golf shirts, lounge shirts, work wear, sweaters, jackets and track suits. The company currently does not supply retailers, but sells directly to corporate customers or marketing and promotions companies only. Clothing can be branded to customer specifications using embroidery and printing.
The company also purchases and sells a range of corporate gifts to its customers, including –
? carry bags and luggage items;
? water bottles, coffee mugs and flasks;
? memory sticks;
? key chains;
? umbrellas;
? business card holders;
? stationery items, such as pens, pencils, folders and notebooks;
? iPad holders; and
? first aid kits.
The gift range can also be branded with company logos and marketing material.
The executive directors of Zimrod collectively own 100% of the shares in issue of the company (there are 100 000 ordinary shares in issue). These shareholders have provided non interest bearing loans to the company in proportion to their shareholdings. Shareholder loans totalled R12 500 000 in 2011 and 2012.
The statement of comprehensive income of Zimrod for the year ended 30 September 2012 and the statement of financial position at 30 September 2012 are set out below.
ZIMROD (PTY) LTD
STATEMENT OF COMPREHENSIVE INCOME
FOR THE YEAR ENDED 30 SEPTEMBER 2012
2012
2011
R’000
R’000
Revenue
317 438
274 600
Cost of sales
(183 479)
(159 268)
Gross profit
133 959
115 332
Operating expenses
(98 937)
(87 710)
Operating profit
35 022
27 622
Finance costs
(1 630)
(1 500)
Profit before taxation
33 392
26 122
Taxation
(9 350)
(7 314)
Profit for the year
24 042
18 808
2
ZIMROD (PTY) LTD
STATEMENT OF FINANCIAL POSITION AT 30 SEPTEMBER 2012
2012
2011
R’000
R’000
Non current assets
Property, plant and equipment
17 380
12 500
Current assets
111 496
91 554
Inventories
50 268
41 453
Trade and other receivables
60 878
48 901
Cash and cash equivalents
350
1 200
Total assets
128 876
104 054
Equity
Share capital
100
100
Retained income
65 917
41 875
66 017
41 975
Non current liabilities
Loans from shareholders
12 500
12 500
Current liabilities
50 359
49 579
Current tax payable
1 402
1 096
Trade and other payables
32 674
30 545
Bank overdraft
16 283
17 938
Total equity and liabilities
128 876
104 054
Ms Jennifer Ireland, the Chief Executive Officer (CEO) of Zimrod, is concerned about the cash flow generation of the company. Operating profit grew by 26,8% in the 2012 financial year (‘FY2012’) yet the net cash position only improved marginally. Ms Ireland is of the opinion that the poor cash flow generation of the company is due to poor working capital management. She would like her shareholder’s loan to be repaid as soon as possible, as she plans to buy a holiday home in Cape Town.
Jaxx Work & Leisure Wear
Zimrod has historically adopted a strategy of importing and selling its own line of clothing, branded ‘Zimrod’, or sourcing clothing to be branded to customers’ requirements. However, the company has been in discussions with Jaxx Work & Leisure Wear (‘Jaxx’), a major North American clothing group which sells Jaxx branded merchandise to clothing retailers in North America and Europe. Jaxx also has its own retail outlets which sell its extensive clothing range and related accessories (sunglasses, gloves, belts, headwear and socks).
Jaxx has offered Zimrod the exclusive right to distribute its product range in sub Saharan Africa. Jaxx currently does not have a presence in Africa and perceives an opportunity to grow its global sales by entering emerging markets.
3
The opportunity to import and distribute the Jaxx product range is appealing to Zimrod for the following reasons:
? It will provide its customers with access to a leading global work and leisure wear brand;
? It will diversify revenue streams, as Zimrod could supply branded merchandise to South African clothing retailers; and
? It will enable Zimrod to enter the retail market directly, should Zimrod decide to open its own retail outlets under the Jaxx brand.
Negotiations between Zimrod and Jaxx have progressed well and agreement has been reached on the following key commercial arrangements:
? The initial licensing and distribution agreement will be for a three year period commencing on 1 January 2013. The agreement will be automatically renewable for another three years thereafter, unless either party terminates the agreement by giving three months’ written notice;
? Zimrod will order and purchase merchandise directly from Jaxx’s head office in Seattle in the United States (US). Zimrod will not pay royalties to Jaxx but rather Jaxx will earn its normal mark ups on selling its product range. Prices will be denominated in US dollar;
? Zimrod will be required to spend a minimum of 2% of its annual sales value of Jaxx products on general marketing and promotion of the Jaxx brand in South Africa and in other territories in which Zimrod will sell Jaxx merchandise;
? Jaxx will supply Zimrod with free samples of products and advertising materials to assist Zimrod in marketing and promoting the brand. In addition, Jaxx will provide Zimrod with access to all forthcoming clothing and product ranges while these are in the planning stage to enable Zimrod to plan new product launches and place orders well in advance of changing seasons; and
? Payment terms for products purchased from Jaxx will be 30 days from statement, which will be e mailed at the end of each month.
The Financial Manager of Zimrod, Mr Jarred Kirchner, was tasked with preparing a capital budget to assess the viability of importing and distributing the Jaxx product range. Mr Kirchner obtained inputs from key management at Zimrod and Jaxx and has incorporated these into the latest draft capital budget, which is summarised below.
For the sake of simplicity, the capital budget is based on the assumption that all cash flows occur at the end of each calendar year unless otherwise indicated and that the agreement with Jaxx will become effective on 1 January 2013:
4
JAXX VENTURE
DRAFT CAPITAL BUDGET
Notes
2012
2013
2014
2015
R’000
R’000
R’000
R’000
Sales
1
0
65 625
103 500
123 038
Purchases – landed cost
2
0
(43 750)
(69 000)
(82 025)
Gross profit
0
21 875
34 500
41 013
Initial marketing campaign
3
(2 500)
0
0
0
Warehousing costs
4
0
(2 188)
(3 450)
(4 101)
Delivery costs
5
0
(1 531)
(2 415)
(2 871)
Operating costs
6
0
(7 560)
(8 316)
(9 148)
Finance costs
7
0
(1 398)
(1 745)
(1 207)
Net profit for the year
(2 500)
9 198
18 574
23 686
Taxation
8
700
(2 576)
(5 201)
(6 632)
Inventory movements
9
(8 500)
(5 884)
(8 301)
(4 282)
Trade receivables movements
10
(13 485)
(7 783)
(4 015)
Trade payables movements
10
5 394
3 113
1 606
Net cash flow for the year
(10 300)
(7 353)
402
10 363
Internal rate of return (IRR)
–17,8%
Funding required
Opening balance
0
(10 300)
(17 653)
(17 251)
Net cash flow for the year
(10 300)
(7 353)
402
10 363
Closing balance
(10 300)
(17 653)
(17 251)
(6 888)
Notes
1 A mark up on the landed cost of products of 50% has been assumed in the capital budget.
2 The cost of purchasing Jaxx products has been based on the forecast rand : US dollar exchange rates which were obtained from Zimrod’s bankers.
3 Zimrod will need to launch a marketing campaign to introduce the Jaxx brand to South African retailers and consumers. It has been assumed that the campaign will be paid for by 31 December 2012.
4 Zimrod has sufficient capacity in its existing warehouse for storing Jaxx products and does not expect to incur any additional costs in handling these products at its warehouse. However, in order to evaluate the Jaxx project objectively, warehousing costs of 5% of the landed cost of products has been included in the capital budget (5% being the percentage Zimrod historical experienced for all product ranges).
5 Costs of delivering products sold to customers averages 3,5% of landed cost.
5
6 Zimrod plans to start a new division which will focus exclusively on Jaxx products. The additional operating expenditure relates to this division and costs will largely be fixed in nature and exclude advertising and marketing expenditure.
7 Zimrod will require additional funding to invest in initial inventory and to cover marketing expenditure and ongoing working capital requirements until the venture is cash positive. It has been assumed that loan finance will be obtained from commercial banks to fund the venture. Finance charges at a rate of 10% per annum have been assumed, based on the average loan balances during the forecast period. No interest income has been included (Zimrod earns 5% on cash deposits) since the venture is forecast to be cash negative for the first three years.
8 Taxation at 28% has been assumed on net profits generated by the Jaxx venture.
9 It has been assumed that Zimrod will initially purchase inventory to the value of R8 500 000 to get the venture off the ground. Thereafter, year end inventories have been assumed to be 120 days’ worth of purchases, as follows:
2012
2013
2014
2015
R’000
R’000
R’000
R’000
Initial inventory
8 500
Year end inventories, 2013 onwards (120 days)
14 384
22 685
26 967
Net movement for the year
(8 500)
(5 884)
(8 301)
(4 282)
10 Trade receivable days of 75 and trade payable days of 45 (based on landed cost of goods) have been assumed throughout the period, and net movements have been calculated as follows:
2013
2014
2015
R’000
R’000
R’000
Trade receivables
Trade receivables at year end (75 days)
13 485
21 268
25 283
Net movement for the year
(13 485)
(7 783)
(4 015)
Trade payables
Trade payables at year end (45 days)
5 394
8 507
10 113
Net movement for the year
5 394
3 113
1 606
Zimrod plans to delay the opening of any Jaxx retail outlets until 2016 to allow the company to establish this brand in South Africa before embarking on the next phase of the plan.
The CEO of Zimrod has reviewed the above draft capital budget and is dismayed by the negative forecast IRR. The Board of Directors of Zimrod has indicated that unless the projected IRR is higher than 30%, the proposed licensing and distribution arrangement with Jaxx will not be approved.
6
The directors derived the 30% hurdle rate on the following basis:
Zimrod weighted average cost of capital (WACC)
=
[80% x cost of equity] + [20% x after tax cost of debt]
20% representing the target debt : equity ratio
Cost of equity
=
Risk free rate + market risk premium
=
Government three month treasury bill rate + 8,0%
=
6,6% + 8,0%
=
14,60%
Cost of debt
=
Current bank overdraft rate x 72%
=
9,0% x 72%
=
6,48%
WACC therefore
=
12,98%
Adjustment for Jaxx venture risk
=
17,02%
Hurdle rate
=
30,00%
The Board of Directors has also indicated that the capital budget should be based on the assumption that the Jaxx venture is a three year project.
Funding for the Jaxx venture
Zimrod has approached its commercial bankers and other banks to provide a R20 million term loan to fund the Jaxx venture. All banks that were approached have declined the loan application, based on their perception that it would be a high risk business venture. Zimrod’s poor cash flow generation in FY2012 also did not help their cause in their bank finance application.
Morningstar Investments Ltd (‘Morningstar’), a listed investment holding group, recently approached Zimrod with a view to acquiring a minority shareholding interest in the company. Morningstar has been actively searching for an entry into the corporate clothing and promotions industry and has received excellent feedback about Zimrod. Morningstar has submitted a letter of interest to the Board of Directors of Zimrod, stating amongst others the following:
? Morningstar is prepared to subscribe for a 30% shareholding in Zimrod based on a valuation of four times the audited profit after tax for the year ended 30 September 2012, as a price earnings multiple of four is what Morningstar usually pays for stakes in private companies. In terms of this the value of Zimrod would be R96 168 000 based on the profit for the year ended 30 September 2012, and Morningstar would inject R28 850 400 into the company in return for a 30% shareholding; and
? Morningstar requires the right to appoint two non executive directors to the Board of Directors of Zimrod.
7
REQUIRED
Marks
Sub total
Total
(a)
Analyse the working capital of Zimrod for the years ended 30 September 2011 and 2012 and indicate, with reasons, whether you agree with the Zimrod CEO’s contention that the poor cash generation of the company is due to poor working capital management.
? Calculate relevant ratios and show all workings.
? Use 365 days of the year for your calculations where relevant.
7
7
(b)
Re draft the capital budget to correct the errors and omissions that you have identified in the draft prepared by the Financial Manager. Also recalculate the projected IRR of the Jaxx venture. Briefly motivate each of your adjustments.
Assume that the mathematical calculations of working capital in the original draft capital budget are correct.
20
20
(c)
Critically discuss the derivation of the 30% hurdle rate required by the Board of Directors for the evaluation of the proposed licensing and distribution arrangement with Jaxx.
10
10
(d)
With regard to the proposed licensing and distribution arrangement with Jaxx –
(i) discuss whether this is an appropriate strategy for Zimrod to pursue, describing both the positive aspects of this alliance and potential concerns you may have from a strategic perspective; and
(ii) identify and explain the key risks to which Zimrod will be subjected if it enters into and pursues the proposed arrangement with Jaxx.
Communication skills – clarity of explanation and logical argument
14
16
2
32
(e)
Draft an executive summary to the Board of Directors in which you recommend, with reasons, whether or not Zimrod should enter into the licensing and distribution arrangement with Jaxx.
Communication skills – appropriate and clear communication
6
2
8
(f)
Discuss the factors that the Board of Directors should consider in evaluating the Morningstar offer.
10
10
(g)
Estimate the pro forma earnings per share of Zimrod for the year ending 30 September 2013, on the assumption that –
? Morningstar subscribed for a 30% shareholding in Zimrod based on a pre subscription valuation of Zimrod of R120 million on 1 October 2012;
? Zimrod’s operating profit, before consideration of the Jaxx venture opportunity, increases by 15% in FY2013 in comparison to FY2012; and
? Zimrod does not enter into the licensing and distribution arrangement with Jaxx.
Consider the following dialogue between a systems professional, Joe Pugh, and a manager of a department targeted for a new information system, Lars Meyer: Pugh: The way to go about the analysis is to first examine the old system, such as reviewing key documents and observing the workers performing their tasks. Then we can determine which aspects are working well and which should be preserved. Meyer: We have been through these types of projects before and what always ends up happening is that we do not get the new system we are promised; we get a modified version of the old system. Pugh: Well, I can assure you that will not happen this time. We just want a thorough understanding of what is working well and what is not. Meyer: I would feel much more comfortable if we first started with a list of our requirements. We should spend some time up front determining exactly what we want the system to do for my department. Then, you systems people can come in and determine what portions to salvage if you wish. Just don’t constrain us to the old system!
Required
a. Obviously these two workers have different views on how the systems analysis phase should be conducted. Comment on whose position you sympathize with the most.
Your company, Kitchen Works, is employing the SDLC for its new information system. The company is currently performing a number of feasibility studies, including the economic feasibility study. A draft of the economic feasibility study has been presented to you for your review. You have been charged with determining whether only escapable costs have been used, the present value of cash flows is accurate, the one time and recurring costs are correct, realistic useful lives have been used, and the intangible benefits listed in the study are reasonable. Although you are a member of the development team because of your strong accounting background, you have questions about whether some costs are escapable, the interest rates used to perform present value analysis, and the estimated useful lives that have been used. How might you resolve your questions?
Listed in Problem are some probability estimates of the costs and benefits associated with two competing projects.
COST BENEFIT ANALYSIS
A
B
Probability
Amount
Probability
Amount
Project completion time
0.5
12 months
0.6
12 months
0.3
18 months
0.2
18 months
0.2
24 months
0.1
24 months
Expected useful life
0.6
4 years
0.5
4 years
0.25
5 years
0.3
5 years
0.15
6 years
0.2
6 years
One time costs
0.35
$200,000
0.2
$210,000
0.4
250,000
0.55
250,000
0.25
300,000
0.25
260,000
Recurring costs
0.1
$ 75,000
0.4
$ 85,000
0.55
95,000
0.4
100,000
0.35
105,000
0.2
110,000
Annual tangible benefits starting with weighted average completion date
0.3
$220,000
0.25
$215,000
0.5
233,000
0.5
225,000
0.2
240,000
0.25
235,000
a. Compute the net present value of each alternative. Round the cost projections to the nearest month. Explain what happens to the answer if the probabilities of the recurring costs are incorrect and a more accurate estimate is as follows:
A
B
.10
$ 75,000
.4
$ 85,000
.55
95,000
.4
100,000
.35
105,000
.2
110,000
b. Repeat step (a) for the payback method.
c. Which method do you think provides the best source of information? Why?
1. Which of the following is the correct sequence of activities in the systems development life cycle?
a. Design, analysis, implementation, and operation.
b. Design, implementation, analysis, and operation.
c. Analysis, design, implementation, and operation.
d. Programming, analysis, implementation, and operation.
2. Which of the following is NOT an output attribute?
a. relevance
b. exception orientation
c. zones
d. accuracy
3. Which of the following is NOT a principal feature of a PERT chart?
a. starting and ending dates
b. events
c. paths
d. activities
4. Internal auditors would most appropriately perform which of the following activities during a review of systems development activity?
a. Serve on the MIS steering committee that determines what new systems are to be developed.
b. Review the methodology used to monitor and control the system development function.
c. Recommend specific automated procedures to be incorporated into new systems that will provide reasonable assurance that all data submitted to an application are converted to machine readable form.
d. Recommend specific operational procedures that will ensure that all data submitted for processing are converted to machine readable form.
5. Which of the following is the least risky strategy for converting from a manual to a computerized system?
1. At which point are errors are most costly to correct?
a. programming
b. conceptual design
c. analysis
d. detailed design
e. implementation
2. User acceptance testing is more important in an object oriented development process than in a traditional environment because of the implications of the
a. absence of traditional design documents.
b. lack of a tracking system for changes.
c. potential for continuous monitoring.
d. inheritance of properties in hierarchies.
3. Which of the following sets of application characteristics of an accounting application might influence the selection of data entry devices and media for a computerized accounting system?
a. Timing of feedback needs relative to input, need for documentation of an activity, and the necessity for reliability and accuracy.
b. Cost considerations, volume of input, complexity of activity, and liquidity of assets involved.
c. Need for documentation, necessity for accuracy and reliability, volume of output, and cost considerations.
d. Relevancy of data, volume of input, cost considerations, volume of output, and timing of feedback needs relative to input.
e. Type of file used, reliability of manufacturer’s service, volume of output, and cost considerations.
4. What is the name given to the systems development approach used to quickly produce a model of user interfaces, user interactions with the system, and process logic?
a. neural networking
b. prototyping
c. reengineering
d. application generation
5. The PERT is combined with cost data to produce a PERT cost analysis to
a. calculate the total project cost inclusive of the additional slack time.
b. evaluate and optimize trade offs between time of an event’s completion and its cost to complete.
c. implement computer integrated manufacturing concepts.
Reeve Lumber Company has a small information systems department consisting of five people. A backlog of approximately 15 months exists for requests for new systems applications to even be considered. Both information users and systems personnel are unhappy with this state of affairs. The users feel that the systems department is not responsive enough to their needs, while the systems personnel feel overworked, frustrated, and unappreciated. Janet Hubert, the manager of the systems department, has decided that she needs to take a proactive measure. She is requesting the funds to purchase a CASE system for approximately $75,000 that takes about 2 months to install and train workers how to use it. The president of the company, Mike Cassidy, initially responded by questioning the wisdom of taking the systems personnel away from their duties when they are backlogged so they can learn a system. Prepare a memo from Hubert to Cassidy. In the memo, outline the expected benefits of purchasing and using a CASE system and address Cassidy’s concern regarding the 2 month training and implementation period.
Robin Alper, a manager of the credit collections department for ACME Building Supplies, is extremely unhappy with a new system that was installed 3 months ago. Her complaint is that the data flows from the billing and accounts receivable departments are not occurring in the manner originally requested. Further, the updates to the database files are not occurring as frequently as she had envisioned. Thus, the hope that the new system would provide more current and timely information has not materialized. She claims that the systems analysts spent 3 days interviewing her and other workers. During that time, she and the other workers thought they had clearly conveyed their needs. She feels as if their needs were ignored and their time was wasted.
Required
What went wrong during the systems design process?
What suggestions would you make for future projects?
Robert Hamilton was hired 6 months ago as the controller of a small oil and gas exploration and development company, Gusher, Inc., headquartered in Beaumont, Texas. Before working at Gusher, Hamilton was the controller of a larger petroleum company, Eureka Oil Company, based in Dallas. The joint interest billing and fixed asset accounting systems of Gusher are outdated, and frequent processing problems and errors have been occurring. Hamilton immediately recognized these problems and informed the president, Mr. Barton, that it was crucial to install a new system. Barton concurred and met with Hamilton and Sally Jeffries, the information systems senior manager. Barton instructed Jeffries to make the new system a top priority. Basically, he told Jeffries to deliver the system to meet Hamilton’s needs as soon as possible. Jeffries left the meeting feeling overwhelmed because the IT department is currently working on two other very big projects, one for the production department and the other for the geological department. The next day, Hamilton sent a memo to Jeffries indicating the name of a system he had 100 percent confidence in—Amarillo Software—and he also indicated that he would very much like this system to be purchased as soon as possible. He stated that the system had been used with much success during the past 4 years in his previous job. When commercial software is purchased, Jeffries typically sends out requests for proposals to at least six different vendors after conducting a careful analysis of the needed requirements. However, due to the air of urgency demonstrated in the meeting with the president and the overworked systems staff, she decided to go along with Hamilton’s wishes and sent only one RFP, which went to Amarillo Software. Amarillo promptly returned the completed questionnaire. The purchase price ($75,000) was within the budgeted amount. Jeffries contacted the four references provided and was satisfied with their comments. Further, she felt comfortable because the system was for Hamilton, and he had used the system for 4 years. The plan was to install the system during the month of July and try it for the August transaction cycle. Problems were encountered, however, during the installation phase. The system processed extremely slowly on Gusher’s hardware platform. When Jeffries asked Hamilton how the problem had been dealt with at Eureka, he replied that he did not remember having such a problem. He called the systems manager from Eureka and discovered that Eureka has a much more powerful mainframe than Gusher. Further investigation revealed that Gusher has more applications running on its mainframe than Eureka does, because Eureka uses a twomainframe distributed processing platform. Further, the data transfer did not go smoothly. A few data elements being stored in the system were not available as an option in the Amarillo system. Jeffries found that the staff at Amarillo was very friendly when she called, but they could not always identify the problem over the phone. They needed to come out to the site and investigate. Hamilton was surprised at the delays between requesting an Amarillo consultant to come out and the time in which he or she actually arrived. Amarillo explained that it had to fly a staff member from Dallas to Beaumont for each trip. The system finally began to work somewhat smoothly in January, after a grueling fiscal year end close in October. Hamilton’s staff views the project as an unnecessary inconvenience. At one point, two staff accountants threatened to quit. The extra consulting fees amounted to $35,000. Further, the systems department at Gusher spent 500 more hours during the implementation process than it had expected. These additional hours caused other projects to fall behind schedule.
Required
Discuss what could have been done differently during the design phase. Why were most of the problems encountered? How might a detailed feasibility study have helped?
The Peabody Coal Corporation recently completed the final feasibility report for a new general ledger accounting system. It has hired a consulting firm to program and install the new system. The consulting firm is charging $350,000 for the remaining tasks to be performed. These tasks are to be performed over the next 10 months as detailed in the Gantt chart in the diagram for Problem 9. The consulting firm is extremely concerned with the project staying on schedule because it is receiving a flat fee. The release of the final payment is contingent upon the system performing as stated in the contract and upon Peabody receiving appropriate documentation of the system.
Required
a. Prepare a PERT diagram and indicate the critical path.
b. What happens to the time frame of the implementation of the project if the manufacturer is 4 weeks late shipping the hardware?
c. What happens if the data conversion does not go smoothly and takes an additional 3 weeks?
d. Who should conduct the post implementation review? What activities should be conducted during this review? Do you think enough time has been allotted for this activity?
The lottery commission of a state with about $500 million a year in revenue has looked to modern technology for increasing lottery sales. The strategy is to place self service sales machines around the state. Customers simply fill out the bubbles on the form and insert the form into the computer. If they wish, they may enter their numbers directly in the computer and skip the form altogether. The machine accepts cash and automatic teller machine cards. The lottery commission is very excited about this project because it thinks it could boost lottery ticket sales by as much as 30 percent. The systems department has finished the final feasibility report and has determined the following estimates for implementing the system. It plans on purchasing a larger, more powerful mainframe computer to handle the processing of the transactions. The manufacturer has promised a delivery date of 3 months from the time the order is placed. The lottery sales machines must be special ordered and require a lead time of 5 months. The plan is to initially order 15 machines and test them for 12 weeks. If all goes well, the lottery commission will order a total of 500 machines, with 20 delivered and installed each month. This order will not be placed until the results of the pilot test have been analyzed. The writing of the programs is expected to take 6 weeks. The testing of the programs on the mainframe is expected to take 4 weeks, with an additional 3 weeks once the sales machines have been received. The state gaming commission is expected to test for another 2 weeks. The design of the databases is expected to take only 2 weeks. Not much data transfer is expected to be necessary, so only 3 weeks is budgeted for this task. An estimated 20 employees need to be hired and trained to install and maintain these machines around the state. The hiring process is expected to take 6 weeks, and the training should take an additional 6 weeks. The documentation should take about 3 months and should be completed before the training of the new employees. As soon as the gaming commission signs off on the programs, the 15 machines are to be installed at test sites around the state. Four weeks are allotted for this installation procedure. A 1 week testing period is planned, with commission employees going to the sites and using the machines. An additional week is planned to review the results of these tests. The pilot test then begins and runs for 8 weeks. The data will be analyzed for 4 weeks after the pilot test. The final order for the additional machines will be placed after the data analysis is conducted and the demand for the number of machines is more accurately determined. Required
a. Prepare a PERT chart for the process described. Identify the critical path.
b. Prepare a Gantt chart for the process described.
1. Which of the following is NOT a requirement in management’s report on the effectiveness of internal controls over financial reporting?
a. A statement of management’s responsibility for establishing and maintaining adequate internal control user satisfaction.
b. A statement that the organization’s internal auditors have issued an attestation report on management’s assessment of the company’s internal controls.
c. A statement identifying the framework management uses to conduct its assessment of internal controls.
d. An explicit written conclusion as to the effectiveness of internal control over financial reporting.
2. Which of the following is NOT an implication of Section 302 of SOX?
a. Auditors must determine whether changes in internal control have materially affected, or are likely to materially affect, internal control over financial reporting.
b. Auditors must interview management regarding significant changes in the design or operation of internal control that occurred since the last audit.
c. Corporate management (including the CEO) must certify monthly and annually their organization’s internal controls over financial reporting.
d. Management must disclose any material changes in the company’s internal controls that have occurred during the most recent fiscal quarter.
3. Which of the following statements is true?
a. Both the SEC and the PCAOB require the use of the COSO framework.
b. Both the SEC and the PCAOB require the COBIT framework.
c. The SEC recommends COBIT, and the PCAOB recommends COSO.
d. Any framework can be used that encompass all of COSO’s general themes.
e. Both c and d are true.
4. Which of the following is NOT a control implication of distributed data processing?
a. redundancy
b. user satisfaction
c. incompatibility
d. lack of standards
5. Which of the following disaster recovery techniques may be least optimal in the case of a widespread natural disaster?
1. Which of the following is NOT a potential threat to computer hardware and peripherals?
a. low humidity
b. high humidity
c. carbon dioxide fire extinguishers
d. water sprinkler fire extinguishers
2. Computer accounting control procedures are referred to as general or application controls. The primary objective of application controls in a computer environment is to
a. ensure that the computer system operates efficiently.
b. ensure the validity, completeness, and accuracy of financial transactions.
c. provide controls over the electronic functioning of the hardware.
d. plan for the protection of the facilities and backup for the systems.
3. Which of the following is NOT a task performed in the audit planning phase?
a. reviewing an organization’s policies and practices
b. determining the degree of reliance on controls
c. reviewing general controls
d. planning substantive testing procedures
4. Which of the following risks does the auditor least control?
a. inherent risk
b. control risk
c. detection risk
d. all are equally controllable
5. Which of the following would strengthen organizational control over a large scale data processing center?
a. Requiring the user departments to specify the general control standards necessary for processing transactions.
b. Requiring that requests and instructions for data processing services be submitted directly to the computer operator in the data center.
c. Having the database administrator report to the manager of computer operations.
d. Assigning maintenance responsibility to the original system designer who best knows its logic.
Avatar Financials, Inc., located on Madison Avenue, New York City, is a company that provides financial advice to individuals and small to mid sized businesses. Its primary operations are in wealth management and financial advice. Each client has an account where basic personal information is stored on a server within the main office in New York City. The company also keeps the information about the amount of investment of each client on a separate server at their data center in Bethlehem, Pennsylvania. This information includes the total value of the portfolio, type of investments made, the income structure of each client, and associated tax liabilities. In the last few years, larger commercial banks have started providing such services and are competing for the same set of customers. Avatar, which prides itself in personal consumer relations, is now trying to set up additional services to keep its current customers. It has recently upgraded its Web site, which formerly only allowed clients to update their personal information. Now clients can access information about their investments, income, and tax liabilities that is stored at the data center in Pennsylvania. As a result of previous dealings, Avatar has been given free access to use the computer room of an older production plant. The company believes that this location is secure enough and would keep the data intact from physical intruders. The servers are housed in a room that the production plant used to house its legacy system. The room has detectors for smoke and associated sprinklers. It is enclosed, with no windows, and has specialized temperature controlled air ducts. Management has recently started looking at other alternatives to house the server as the plant is going to be shut down. Management has major concerns about the secrecy of the location and the associated measures. They want to incorporate newer methods of physical data protection. The company’s auditors have also expressed a concern that some of the measures at the current location are inadequate and newer alternatives should be found.
Required
1. Why are the auditors of Avatar stressing the need to have better physical environment for the server? If
Avatar has proper software controls in place, would that not be enough to secure the information?
2. Name the six essential control features that contribute directly to the security of the computer server environment.
In reviewing the process procedures and internal controls of one of your audit clients, Steeplechase Enterprises, you notice the following practices in place. Steeplechase has recently installed a new computer system that affects the accounts receivable, billing, and shipping records. A specifically identified computer operator has been permanently assigned to each of the functions of accounts receivable, billing, and shipping. Each of these computer operators is assigned the responsibility of running the program for transaction processing, making program changes, and reconciling the computer log. To prevent any single operator from having exclusive access to the tapes and documentation, these three computer operators randomly rotate the custody and control tasks every 2 weeks over the magnetic tapes and the system documentation. Access controls to the computer room consist of magnetic cards and a digital code for each operator. Access to the computer room is not allowed to either the systems analyst or the computer operations supervisor. The documentation for the system consists of the following: record layouts, program listings, logs, and error listings. Once goods are shipped from one of Steeplechase’s three warehouses, warehouse personnel forward shipping notices to the accounting department. The billing clerk receives the shipping notice and accounts for the manual sequence of the shipping notices. Any missing notices are investigated. The billing clerk also manually enters the price of the item and prepares daily totals (supported by adding machine tapes) of the units shipped and the amount of sales. The shipping notices and adding machine tapes are sent to the computer department for data entry. The computer output generated consists of a two copy invoice and remittance advice and a daily sales register. The invoices and remittance advice are forwarded to the billing clerk, who mails one copy of the invoice and remittance advice to the customer and files the other copy in an open invoice file, which serves as an accounts receivable document. The daily sales register contains the total of units shipped and sales amounts. The computer operator compares the computer generated totals to the adding machine tapes. Required
Identify the control weaknesses present and make a specific recommendation for correcting each of the control weaknesses.
The internal audit department of a manufacturing company conducted a routine examination of the company’s distributed computer facilities. The auditor’s report was critical of the lack of coordination in the purchase of PC systems and software that individual departments use. Several different hardware platforms, operating systems, spreadsheet packages, database systems, and networking applications were in use. In response to the internal audit report, and without consulting with department users regarding their current and future systems needs, Marten, the Vice President of Information Services, issued a memorandum to all employees stating the following new policies:
1. The Micromanager Spreadsheet package was selected to be the standard for the company, and all employees must immediately switch to it within the month.
2. All future PC purchases must be Mega soft compatible.
3. All departments must convert to the Mega soft Entre ´e database package.
4. The office of the Vice President of Information Services must approve all new hardware and software purchases. Several managers of other operating departments have complained about Marten’s memorandum. Apparently, before issuing this memo, Marten had not consulted with any of the users regarding their current and future software needs.
Required
a. When setting systems standards in a distributed processing environment, discuss the pertinent factors about:
1. Computer hardware and software considerations.
2. Controls considerations.
b. Discuss the benefits of having standardized hardware and software across distributed departments in the firm.
c. Discuss the concerns that the memorandum is likely to create for distributed users in the company.
1) The Fed”s failure to exercise effective control over the money supply during the 1979 1982 period
A) proves that such control is not possible.
B) resulted because forces outside of its control removed the link between open market operations and the money supply.
C) occurred despite evidence of a strong link between open market operations and the money supply.
D) stems from the Treasury Federal Reserve Accord.
2) Large fluctuations in money supply growth and smaller fluctuations in the federal funds rate between October 1982 and the early 1990s indicate that the Fed had shifted to ________ as an operating target.
A) borrowed reserves
B) nonborrowed reserves
C) excess reserves
D) required reserves
3) The strengthening of the dollar between 1980 and 1985 contributed to a ________ in American competitiveness, putting pressure on the Fed to pursue a more ________ monetary policy.
1) A borrowed reserves target is ________ because increases in income ________ interest rates and discount loans, causing the Fed to ________ the monetary base, everything else held constant.
A) procyclical; increase; increase
B) countercyclical; increase; increase
C) procyclical; reduce; reduce
D) countercyclical; reduce; reduce
2) Fed policy since the early 1990s indicates that it is pursuing a policy of targeting the
A) monetary base.
B) money supply.
C) federal funds interest rate.
D) exchange rate.
3) Since the early 1990s, the Fed has conducted monetary policy by setting a target for the
1) The fluctuations in both money supply growth and the federal funds rate during 1979 1982 suggest that the Fed
A) had shifted to borrowed reserves as an operating target.
B) had shifted to total reserves as an operating target.
C) had shifted to the monetary base as an operating target.
D) never intended to target monetary aggregates.
Fed Policy Procedures: Historical Perspective
2) The Fed can engage in preemptive strikes against a rise in inflation by ________ the federal funds interest rate; it can act preemptively against negative demand shocks by ________ the federal funds interest rate.
Sachs Brands’ defined benefit pension plan specifies annual retirement benefits equal to: 1.3% × service years × final year’s salary, payable at the end of each year. Angela Davenport was hired by Sachs at the beginning of 1999 and is expected to retire at the end of 2033 after 35 years’ service. Her retirement is expected to span 18 years. Davenport’s salary is $87,000 at the end of 2013 and the company’s actuary projects her salary to be $265,000 at retirement. The actuary’s discount rate is 9%. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)
Required:
2.
Estimate by the accumulated benefits approach the amount of Davenport’s annual retirement payments earned as of the end of 2013.
3.
What is the company’s accumulated benefit obligation at the end of 2013 with respect to Davenport?
4.
If no estimates are changed in the meantime, what will be the accumulated benefit obligation at the end of 2016 (three years later) when Davenport’s salary is $100,000?
An aging of a company’s accounts receivable indicates that $4,500 are estimated to be uncollectible. If Allowance for Doubtful Accounts has a $1,200 credit balance, the adjustment to record bad debts for the period will require a debit to Allowance for Doubtful Accounts for $3,300. debit to Bad Debt Expense for $3,300. credit to Allowance for Doubtful Accounts for $4,500. debit to Bad Debt Expense for $4,500. The financial statements of the Melton Manufacturing Company reports net sales of $300,000 and accounts receivable of $50,000 and $30,000 at the beginning of the year and end of year, respectively. What is the average collection period for accounts receivable in days? 48.7 96.1 36.5 60.8 Stine Company purchased machinery with a list price of $64,000. They were given a 10% discount by the manufacturer. They paid $400 for shipping and sales tax of $3,000. Stine estimates that the machinery will have a useful life of 10 years and a residual value of $20,000. If Stine uses straight line depreciation, annual depreciation will be $4,100. $3,760. $4,072. $6,100. On January 1, a machine with a useful life of five years and a residual value of $40,000 was purchased for $120,000. What is the depreciation expense for year 2 under the double declining balance method of depreciation? $38,400. $23,040. $28,800. $48,000. As a recent graduate of State University you’re aware that IFRS requires component depreciation for plant assets. A friend has asked you to succinctly explain what component depreciation means. Which of the following correctly describes component depreciation? The method used to prorate annual depreciation on a time basis. The method of depreciation recommended for an asset that is expected to be significantly more productive in the first half of its useful life. The method that requires that significant parts of a plant asset with different useful lives be depreciated separately. The method used to ensure that the depreciation rate remains constant from year to year. Link to Text Given the following account balances at year end, compute the total intangible assets on the balance sheet of Janssen Enterprises. Cash $1,500,000 Accounts Receivable 4,000,000 Trademarks 1,000,000 Goodwill 2,500,000 Research & Development Costs 2,000,000 $7,500,000. $9,500,000. $5,500,000. $3,500,000. Bonds with a face value of $300,000 and a quoted price of 97¼ have a selling price of $291,750. $291,075. $292,500. $291,006. Sparks Company received proceeds of $423,000 on 10 year, 8% bonds issued on January 1, 2013. The bonds had a face value of $400,000, pay interest annually on December 31st, and have a call price of 102. Sparks uses the straight line method of amortization. What is the carrying value of the bonds on January 1, 2015? $400,000 $381,600 $418,400 $420,700 S. Lawyer performed legal services for E. Corp. Due to a cash shortage, an agreement was reached whereby E. Corp. would pay S. Lawyer a legal fee of approximately $15,000 by issuing 8,000 shares of its common stock (par $1). The stock trades on a daily basis and the market price of the stock on the day the debt was settled is $1.80 per share. Given this information, the best journal entry for E. Corp. to record for this transaction is Legal Expense 15,000 Common Stock 8,000 Paid in Capital in Excess of Par Common 7,000 Legal Expense 15,000 Common Stock 15,000 Legal Expense 14,400 Common Stock 8,000 Paid in Capital in Excess of Par Common 6,400 Legal Expense 14,400 Common Stock 14,400 Link to Text Logan Corporation issues 50,000 shares of $50 par value preferred stock for cash at $60 per share. The entry to record the transaction will consist of a debit to Cash for $3,000,000 and a credit or credits to Preferred Stock for $2,500,000 and Retained Earnings for $500,000. Paid in Capital from Preferred Stock for $3,000,000. Preferred Stock for $3,000,000. Preferred Stock for $2,500,000 and Paid in Capital in Excess of Par Value—Preferred Stock for $500,000. Jahnke Corporation issued 8,000 shares of €2 par value ordinary shares for €11 per share. The journal entry to record the sale will include a debit to Cash for €16,000. a credit to Share Premium–Ordinary for €72,000. a credit to Share Capital–Ordinary for €88,000. a debit to Retained Earnings for €72,000. Link to Text Zoum Corporation had the following transactions during 2014: 1. Issued $125,000 of par value common stock for cash. 2. Recorded and paid wages expense of $60,000. 3. Acquired land by issuing common stock of par value $50,000. 4. Declared and paid a cash dividend of $10,000. 5. Sold a long term investment (cost $3,000) for cash of $3,000. 6. Recorded cash sales of $400,000. 7. Bought inventory for cash of $160,000. 8. Acquired an investment in Zynga stock for cash of $21,000. 9. Converted bonds payable to common stock in the amount of $500,000. 10. Repaid a 6 year note payable in the amount of $220,000. What is the net cash provided by financing activities? $395,000. $. $. $105,000. olie Company had an increase in inventory of $120,000. The cost of goods sold was $490,000. There was a $30,000 decrease in accounts payable from the prior period. Using the direct method of reporting cash flows from operating activities, what were Colie’s cash payments to suppliers? $310,000. $580,000. $640,000. $370,000. Each of the following items may be classified as operating or financing activities under IFRS except dividends received. interest paid. all of these answer choices may be classified as such. dividends paid. The current assets of Orangatte Company are $227,500. The current liabilities are $130,000. The current ratio expressed as a proportion is 1.75:1. .57:1. 175%. $210,000 ÷ $120,000. All of the following requirements about internal controls were enacted under the Sarbanes Oxley Act of 2002 except: companies must develop sound internal controls over financial reporting. independent outside auditors must attest to the level of internal control. companies must continually assess the functionality of internal controls. independent outside auditors must eliminate redundant internal control. Which of the following is not an internal control activity for cash? Surprise audits of cash on hand should be made occasionally. All cash receipts should be recorded promptly. The number of persons who have access to cash should be limited. The functions of record keeping and maintaining custody of cash should be combined. Link to Text Before a check authorization is issued, the following documents must be in agreement, except for the invoice. purchase order. remittance advice. receiving report. Mitchell Corporation bought equipment on January 1, 2014 .The equipment cost $180,000 and had an expected salvage value of $30,000. The life of the equipment was estimated to be 6 years. The book value of the equipment at the beginning of the third year would be $130,000. $50,000. $180,000. $150,000. Brevard Corporation purchased a taxicab on January 1, 2013 for $25,500 to use for its shuttle business. The cab is expected to have a five year useful life and no salvage value. During 2014, it retouched the cab’s paint at a cost of $1,200, replaced the transmission for $3,000 (which extended its life by an additional 2 years), and tuned up the motor for $150. If Brevard Corporation uses straight line depreciation, what annual depreciation will Brevard report for 2014? $5,100. $3,900. $4,125. $4,100. On July 1, 2014, Fleming Company sells machinery for $120,000. The machinery originally cost $300,000, had an estimated 5 year life and an expected salvage value of $50,000. The Accumulated Depreciation account had a balance of $175,000 on January 1, 2014, using the straight line method. The gain or loss on disposal is $20,000 gain. $5,000 loss. $10,000 loss. $5,000 gain. On July 1, 2014, Linden Company purchased the copyright to Norman Computer Tutorials for $140,000. It is estimated that the copyright will have a useful life of 5 years. The amount of Amortization Expense recognized for the year 2014 would be $14,000. $25,900. $28,000. $13,125. The following totals for the month of April were taken from the payroll records of Metz Company. Salaries $30,000 FICA taxes withheld 2,295 Income taxes withheld 6,600 Medical insurance deductions 1,200 Federal unemployment taxes 240 State unemployment taxes 1,500 The entry to record accrual of employer’s payroll taxes would include a credit to Payroll Tax Expense for $4,035. credit to FICA Taxes Payable for $1,740. credit to Payroll Tax Expense for $1,740. debit to Payroll Tax Expense for $4,035. Thayer Company purchased a building on January 2 by signing a long term $2,520,000 mortgage with monthly payments of $23,100. The mortgage carries an interest rate of 10 percent. The amount owed on the mortgage after the first payment will be $2,499,000. $2,496,900. $2,517,900. $2,520,000. The following data is available for BOX Corporation at December 31, 2014: Common stock, par $10 (authorized 30,000 shares) $250,000 Treasury stock (at cost $15 per share) $1,200 Based on the data, how many shares of common stock are outstanding? 29,920. 30,000. 24,920. 25,000. Indicate the respective effects of the declaration of a cash dividend on the following balance sheet sections: Total Assets Total Liabilities Total Stockholders’ Equity No change Increase Decrease Decrease No change Increase Decrease Increase Decrease Increase Decrease No change Assume the following cost of goods sold data for a company: 2015 $1,300,000 2014 1,200,000 2013 1,000,000 If 2013 is the base year, what is the percentage increase in cost of goods sold from 2013 to 2015? 70% 30% 130% 20% A company has an average inventory on hand of $75,000 and its average days in inventory is 36.5 days. What is the cost of goods sold? $750,000 $876,000 $1,752,000 $1,680,000 The following information is available for Patterson Company: 2014 2013 Accounts receivable $ 360,000 $ 340,000 Inventory 280,000 320,000 Net credit sales 3,000,000 2,600,000 Cost of goods sold 1,500,000 840,000 Net income 300,000 170,000 The accounts receivable turnover for 2014 is 4.3 times. 8.6 times. 7.6 times. 8.3 times. All of the following situtations below might indicate a company has a low quality of earnings except Maintenance costs are capitalized and then depreciated. Revenue is recognized when earned. A lack of disclosure about guaranteed payments that were mentioned in the MD&A of the annual report. Adoption of a different inventory method for each of the last three years. IFRS Multiple Choice Question 05 IFRS implies that receivables with different characteristics should be reported separately. requires that receivables with different characteristics should be reported separately. requires that receivables with different characteristics should be reported as one unsegregated amount. implies that receivables with different characteristics should be reported as one unsegregated amount.
In our Feature Story about Super Bakery, Inc., we described a virtual corporation as
one that consists of a core unit that is supported by a network of outsourced activities. A virtual
corporation minimizes investment in human resources, fixed assets, and working capital. The application
of ABC to Super Bakery, Inc. is described in an article entitled “ABC in a Virtual Corporation”
by Tim Davis and Bruce Darling, in the October 1996 issue of Management Accounting.
Instructions
Assume you are the controller of a virtual corporation. Using the article as a basis for your communication, write a summary that answers the following questions.
(a) What unique strategies and tactics did Super Bakery’s management implement that caused
sales to take off and continue to grow at an average rate of 20%?
(b) Why did Super Bakery’s management feel that it was necessary to install an ABC system?
(c) What is the main difference between Super Bakery’s ABC system and other manufacturers’
Learning Objective 2 E25 10 Making special pricing decisions Suppose the Baseball Hall of Fame in Cooperstown, New York, has approached 1. $5,700 Hobby Cardz with a special order. The Hall of Fame wishes to purchase 57,000 baseball card packs for a special promotional campaign and offers $0.41 per pack, a. total of $23,370.1 lobby Can1is total production cost is $0.61 per pack, as follow
Variable costs: Direct materials S 0.13 Direct labor 0.06 Variable overhead 0.12 Road overhead 0_30 Total cost $ 0.61
Hobby Cardz has enough excess capacity to handle the special order,
Requirements 1. Prepare a differential analysis to determine whether Hobby Caxdz should accept the special sales order. 2. Now assume that the Hall of Fame wants special hologram baseball cards. Hobby Cardz will spend $5,900 to develop this hologram, which will be use less after the spacial order is completed. Should Hobby7Catdz, accept the special order under these circommances; assuming no &Irwin die special pridng of $0.41 per pack?
Assessment Page 1 of 1 AC203: Managerial Accounting > Week 4 > Assignment > Writing Assignment 2 Question 1 of 1: Calculation of Contribution Margin Income Statement Elapsed Time: Time Remaining: Introduction: This assignment will help you learn to determine the contribution margin ratio, use a cost volume profit analysis to find the breakeven points, and target profit volumes for a company. Tasks: Read the scenario below and answer the questions that follow. A traveling circus puts on 120 performances per year. Each performance sells 1,000 tickets at $45 per ticket. The circus has a cast of 45 performers. Each performer earns $300 per circus performance. The performers are paid after each performance. Other variable expenses include a program printing expense of $9 per customer. Annual fixed expenses for the circus total $787,500. Requirements: 1. Compute revenue and variable expenses for each show. 2. Compute the number of shows needed each year to break even. 3. Compute the number of performances needed each year to earn a profit of $3,262,500. 4. Is the goal of earning profit of $3,262,500 realistic? Explain why or why not. Provide a rationale to support your response. 5. Prepare the circus’ contribution margin income statement for 120 shows each year. Report only fixed and variable expenses. Deliverables and Format: • Submit answers for all requirements as an Excel document to show your calculations. • Create a new tab for this requirement and specify the respective requirement number. References: null Answer /response: Attachments: Attach/Remove Fde I << Previous Question I Skip Question >> ….. SHe a. Eait J http://online.dwc.edu/online/valdoc/clikslndep _ startTest?_i= 1404950406235 2699301007 … 0 min Unl’lmited Bookmark ,.Review 7/9/2014
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Assessment Page 1 of 1 Elapsed Time: 0 min AC203: Managerial Accounting > Week 4 > Assignment > Writing Assignment 2 Time Unl’lmited Remaining: Bookmark Question 1 of 1: Calculation of Contribution Margin Income Statement Introduction: This assignment will help you learn to determine the contribution margin ratio, use a cost volume profit analysis to find the breakeven points, and target profit volumes for a company. Tasks: Read the scenario below and answer the questions that follow. A traveling circus puts on 120 performances per year. Each performance sells 1,000 tickets at $45 per ticket. The circus has a cast of 45 performers. Each performer earns $300 per circus performance. The performers are paid after each performance. Other variable expenses include a program printing expense of $9 per customer. Annual fixed expenses for the circus total $787,500. Requirements: 1. Compute revenue and variable expenses for each show. 2. Compute the number of shows needed each year to break even. 3. Compute the number of performances needed each year to earn a profit of $3,262,500. 4. Is the goal of earning profit of $3,262,500 realistic? Explain why or why not. Provide a rationale to support your response. 5. Prepare the circus’ contribution margin income statement for 120 shows each year. Report only fixed and variable expenses. Deliverables and Format: • Submit answers for all requirements as an Excel document to show your calculations. • Create a new tab for this requirement and specify the respective requirement number. References: null Answer /response: Attach/Remove Fde I Attachments: ,.Review << Previous Question I Skip Question >> ….. SHe a. Eait J http://online.dwc.edu/online/valdoc/clikslndep _ startTest?_i= 1404950406235 2699301007 … 7/9/2014
The student should demonstrate their understanding of the textbook concepts of Financial Statements by analyzing Financial Statements that have been published for the external user via the corporation’s Annual Report.
The student should demonstrate their writing communication skills by delivering the results of the analysis in a written report.
Instructions:
Obtain the most current Annual Report of an aviation related corporation (e.g. Delta, Boeing). You will need the following Consolidated financial statements:
Income Statement (Statement of Operations)
Balance Sheet (Statement of Financial Position)
Statement of Changes in Stockholder’s Equity
Statement of Cash Flows
Report of Independent Auditors of their opinion on financial statements
Answer the Discussion Questions in written paragraph form. The questions should be answered in complete sentences with thorough explanations. There is no set length, but an approximate length is 4 5 pages.
It is very important that you incorporate textbook concepts when answering these questions in addition to your opinions.
The paper must be written using APA Style. Your report should consist of a Title Page, Introduction/Company Overview, desired headings for discussion question coverage, Conclusion, and References. Special care should be taken with grammar, punctuation, and spelling. You should use proper citations and reference page. Be very careful of PLAGIARISM!!!!!
Attach a copy of the Financial Statements and Auditor’s Letter that you used for your project.
Discussion Questions:
Using the Consolidated Statement of Income determine the net income of this company for the most current year. Using the Consolidated Statement of Cash Flows determine the Cash Provided by (from) Operating Activities for the most current year. Compare the two numbers. What do you think is causing this difference? Explain.
Using your company’s Consolidated Income Statement, determine the ratio of net income to net revenue or sales. Do this for the three most recent years. Do you think the company is becoming more or less efficient? Explain.
Using the company’s Consolidated Balance Sheet (Statement of Financial Position), determine the three largest Assets, be sure to look at all the assets, not just the Current Assets. Explain whether you believe the company has invested in the appropriate types of assets for this company.
Using your company’s balance sheet, determine the Current Ratio for both year ends. What does this tell you about your company?
Using your company’s balance sheet, determine the total liabilities. Then compare them to the total assets. This is called the Debt/Asset ratio. What does this indicate about the risk of your company?
Using the company’s Consolidated Statement of Stockholders’ (Shareholders’) Equity, find the Retained Earnings column for the most recent year. Another place to look is the Cash Flow from Financing Activities on the Statement of Cash Flows. State whether your company is paying dividends. If so, how much are the dividends? Do you think the company is making a good decision in paying or not paying dividends?
Using the Consolidated Statement of Cash Flows of this company, identify a decision the company would make concerning financing activities and investing activities. Was the cash flow positive or negative from investing activities and financing activities? What does each of these suggest about this company’s financial health?
Is the net cash flow from operating activities positive or negative? Has it increased or decreased from the previous years? What does this indicate about your company?
i. Read the Independent Auditors’ Report for your company. Is it a qualified or unqualified opinion? How did you determine this? What is your opinion concerning the reliability of an Independent Auditors’ opinion?
Signed a one year 18.5%, $180,000 note payable with First Bank.
June 1
Purchased 3,000 GPS units on Credit from Navistar for $35.00 per unit.
June 1
Issued 5,500 shares of common stock for $11 per share (Refer to General ledger for description of common stock).
June 1
Sold 2,000 DVD players on account to Toyota for $75 per units, Invoice #5555.
June 2
Sold 3,500 GPS units on account to Kia for $52 per unit, Invoice #5556.
June 2
Purchases office supplies from Office Max on credit for $1,200.
June 2
Sold 900 docking stations for $64 per unit and 1950 GPS units for $83 per unit on account to Nissan, Invoice #5560.
June 3
The Board of Directors declared a cash dividend of $5 per share for shareholders of record on June 5th, payable on June 12th.
June 4
Received payment from Toyota for May 11th sale
June 4
Rented part of the warehouse to a new tenant and received $4,900 for three months rent (June, July, August).
June 5
Paid $2,100 to Michigan Utility Co. for utilities bill that was recorded in May as an Account Payable, Check #5278.
June 7
Received and paid expense reports for travel and entertainment totaling $925, Check #5279.
June 8
Paid for office supplies purchased on June 2nd, Check #5280.
June 11
Paid in full for the June 1 purchase from Navistar, Check #5281.
June 11
Received a bill from the law firm of Larry, Moe & Curly for $5,400, payable upon receipt, for bond consulting fees, Check #5282.
June 12
Paid the dividend that was declared on June 3, Check #5283.
June 13
Took advantage of a special deal to purchase 3,250 DVD players on account from JVC for $48 per unit.
June 13
Purchased 850 GPS units on credit from Magellan for $33 per unit.
June 15
Sold 2,000 DVD players on credit to Fort Motor Co. for $89.00 per unit, Invoice 5557.
June 15
Check # 5284 was issued for payroll: $14,500 for salaried and $4,750 for wages.
June 16
Purchased 1,800 docking stations on credit from Samsung for $42 per unit.
June 17
Issued a credit to Kia for the return of 350 defective units from the June 2nd sale. These units has a cost basis of $35 per unit.
June 17
Returned the 350 defective units received from Kia to Navistar.
June 18
Received payment in full from Toyota for the June 1st sale.
June 20
While inspecting the June 13th purchase, it was discovered that the GPS units were programmed for South America instead of North America. AC Speed returned the entire order to Magellan.
June 20
A bankruptcy judge disallowed AC Speed’s claim for $5,000 due from General Motors. Management Decided to write off this accounts receivable.
June 22
Sold 1,650 docking stations on credit to Kia for $64.50 per unit, Invoice #5559.
June 23
Paid $75,000 of the $162,500 owed to JVC from May 25, Check #5285.
June 23
Received payment from Ford Motor Co. for $175,000 of the $300,000 owed from May 5.
June 24
Purchased a $100 international phone card for one of the sales representative’s upcoming European business trip, Check #5286.
June 25
Paid in full for the purchase from JVC on June 13, Check #5287
June 26
Purchased 1,250 docking station from Samsung for $41 per unit paying in cash, Check #5288
June 27
Sold 1,500 docking stations on credit to Honda for $61 per unit, Invoice 5558.
June 27
Hired and paid a consultant $75,000 to devise a marketing plan. AC Speed’s management felt this was necessary to develop brand awareness. Check #5289.
June 28
AC Speed is behind in its mortgage payments to Bank of America. Paid a total of $10,000 ($2,000 principal and $8,000 interest), Check #5290.
June 29
Received payment in full from Honda for the June 27th transaction.
June 29
Paid in full for the purchase from Magellan on May 31st, Check #5291.
June 29
Check #5292 was issued for payroll: $14,500 for salaries and $4,750 for wages.
June 30
Paid the first month’s principal payment of $15,000 on the note payable. In addition, paid one month’s interest, Check #5293
June 30
Issued bonds payable at face value for $350,000
*All purchases of inventory on account terms of 2/15, n/30
**All credit sales have terms of 2/30, n/45
June Month end Adjustments:
( A )
AC Speed has earned one month of the prepaid rent received from their tenant at the beginning of June.
( B )
The Company took a physical count of Office Supplies on June 30 and found the following to be on hand:
Office Supplies $2,465
( C )
AC Speed estimates bad debt expense on a monthly basis rather than waiting until year end. The company uses the allowance method. Based on recent industry estimates, AC Speed estimates that the allowance account should be 2.5% of accounts receivable.
( D )
The Company took a physical inventory count on June 30 and found the following inventory on hand:
Merchandise Inventory $122,221
( E )
The Balance in the prepaid insurance account at the beginning of June represents 4 months of coverage. Record the amount of insurance for June.
( F )
Depreciation on the company’s fixed assets for the month of June is as follows:
1. The furniture and equipment for the warehouse was purchased a few years ago for $10,000. These assets have a 5 year life, an expected salvage value of $1,000, and are depreciated using the straight line method.
2. The furniture and equipment for the office was purchased last year for $8,500. these assets have a 7 year life, an expected salvage value of $1,500, and are depreicated using stright line method.
Mountain Home Properties is developing a subdivision that includes 350 home lots. The 170 lots in the Canyon section are below a ridge and do not have views of the neighboring canyons and hills; the 180 lots in the Hilltop section offer unobstructed views. The expected selling price for each Canyon lot is $48,000 and for each Hilltop lot is $107,000. The developer acquired the land for $1,900,000 and spent another $2,200,000 on street and utilities improvements.
Required:
Assign the joint land and improvement costs to the lots using the market value as the basis of allocation AND determine the average cost per lot.
: You project is to research and write a ten page paper wherein you estimate the demand for money using regression analysis; regression analysis is explained in chapter 5 and can be done in Excel; no, it is not to estimate why people demand money for a major expenditure; rather, it is to estimate the demand curve for money; or why do people hold their wealth in the form of money (use M1 as your measure of money) rather than another asset that will provide a rate of return higher than the rate on one’s checking account, or cash.
All data for the project can be downloaded into an Excel spreadsheet from the St. Louis Federal Reserve Bank site (Google fred ii to find the site).
Your project is to have the following headings and the following headings only:
I. Introduction
II. Literature Review
here you will need to cite at least two scholarly articles
related to estimating the demand for money
III. Model
here your model should look something like this:
M1 = a + b1interest + b2 time
where a is the intercept estimate, b1 is the coefficient estimate on an interest rate (the interest rate is a proxy for the price of money; or the interest you give up by holding money is the opportunity cost of holding your wealth in the form of money) and b2 is the coefficient estimate on the variable time; time is a proxy for all other things and is to account for the identification problem (see chapter 5), or to acknowledge that Ceteris is not Paribus in the real world. You may want to Google “regression analysis” and read up on it. The model should reflect the demand materials in chapter 3
IV. Results of the Model
here you analyze the results of the regression a la chapter 5.
V. Summary and Conclusions
The project/term paper is due Tuesday of week 10 at 6:00 pm CDT or CST and should be submitted to me as a Word document attached to an e mail. Please only attach one document.
The ABC Company was established on the 02nd January 2014 and engages in the sale of shoes. The owners of ABC Company Jack Little and Tom Brown both invested $200,000 each on the 02nd January 2014. On the same day they borrowed $100,000 from the bank at an interest rate of 8% per annum.
On 03rd January they bought shoes valued at $100,000 for which they paid $50,000 cash and the balance from their supplier on 30 days credit.
Their Policy is to buy shoes at the end of every quarter valued at $100,000 on the same terms and conditions $50,000 cash and $50,000 credit.
On 02nd January they paid rent for a store on Main Street. The lease agreement is $7,000 per month. For the year 2014 they paid their rent to date and on time. They have also incurred lease hold improvement for the store in the amount of $30,000 (For the month of Jan).
Their wages for the store was $20,000 in 2014, utilities for 2014 was 415,000, telephone for the year 2014 was $6,000, they gave a cash advance to staff at the start of the year valued at $10,000. Furniture and Fixtures were acquired at the beginning of the year valued at $20,000.
No inventory was left at the end of the year and mark up cost was 30%. All sales were on cash (Mark up on cost). Their opening bank balance at the beginning of the year was $0.
Please provide an opening balance sheet as of 02nd January 2014 and closing balance 31st December 2014.
I am doing group project. This is I become fictional audit firm and I am planning auditing proposal and prcedure and program. i want to know How can I start it and How can I analysis with them. This is group project so, My part is income statement. they said to me analysis 2011 vs 2012 and then, find the risk and step forward for the analytic. I would like to get tutoring about what is step and how can I calculated and What procedure do I have to do. I am totally lost
Year ended December31,
based on 2012
based on 2011
2013
2012
2011
2013 vs. 2012
2012 vs. 2011
Net revenue:
Software
68,897
54,705
39,870
$ 14,192
26%
14,835
37%
You can even say that since revenue has been increasing every year, and I think there gross profit margin also, that could even be pretty risky also, and we would have to find out what is causing that change to make sure the numbers are being properly recorded. So just anything that stands out to you feel free to document, and share your results with Jackie cause we use both comparisons together to see what’s going on with the numbers.
Pueblo Industries invested its excess cash in the following instruments during December 2012:
Certificate of deposit, due January 31, 2013
$ 39,000
Certificate of deposit, due June 30, 2013
95,000
Investment in City of Elgin bonds, due May 1, 2014
15,000
Investment in Quantum Data stock
66,000
Money market fund
105,000
90 day Treasury bills
88,000
Treasury note, due December 1, 2013
200,000
Required:
Determine the amount of cash equivalents that should be combined with cash on the company’s balance sheet at December 31, 2012, and for purposes of preparing a statement of cash flows for the year ended December 31, 2012
What is contribution margin ratio and when is it most useful? How is the breakeven equation modified to take into account the sales required to earn a target profit? Suppose two companies are the same except that company A has more variable costs than fixed costs. Company B has more fixed costs than variable costs. When sales increase, which company will realize the greatest increase in profits?
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What is contribution margin ratio and when is it most useful? How is the breakeven equation modified to take into account the sales required to earn a target profit? Suppose two companies are the same except that company A has more variable costs than fixed costs. Company B has more fixed costs than variable costs. When sales increase, which company will realize the greatest increase in profits?
For the exclusive use of K. Tuttle BUSINESS SCHOOL 9 105 010
REV: AUGUST 12, 2004
JAMES W. CULLITON DAVID F. HAWKINS JACOB COHEN
Superior Manufacturing Company
In February 2005, Herbert Waters was appointed general manager of the Superior Manufacturing Company by Paul Harvey, president. Waters, 56, had wide executive experience in manufacturing products similar to those of Superior. The appointment of Waters resulted from management problems arising from the death of Richard Harvey, founder and, until his death in early 2004, president of Superior. Paul Harvey had only four years’ experience with the company, and in early 2005 was 34 years old. His father had hoped to train him over a 10 year period, but his untimely death had cut this seasoning period short. The younger Harvey became president when his father died and had exercised full control until he hired Waters.
New Management Paul Harvey knew that during 2004 he had made several poor decisions and noted that morale of the organization had suffered, apparently through lack of confidence in him. When he received the income statement for 2004 (see Exhibit 1) showing a net loss of $688,000 during a good business year, he knew he needed help. He attracted Waters from a competitor by offering a stock option incentive in addition to salary, knowing that Waters wanted to acquire a financial competence for his retirement. The two men came to a clear understanding that Waters, as general manager, had full authority to execute any changes he desired. In addition, Waters would explain the reasons for his decisions to Harvey and thereby train him for successful leadership upon Waters’s retirement. Upon taking office in February 2005, Waters decided against immediate major changes. Rather, he chose to analyze 2004 operations and to wait to see results for the first half of 2005. He instructed the accounting department to provide detailed expenses and earnings statements by products and departments for 2004 (see Exhibit 2). In addition, he requested an explanation of the nature of the company’s costs including their expected future behavior (see Exhibit 3).
Company and Industry The Superior Manufacturing Company made only three industrial products: 101, 102, and 103. They were sold by the company’s sales force for use in the processes of other manufacturers. All of the sales force, on a salary basis, sold the three products but in varying proportions. Superior sold
Professor James W. Culliton prepared the original version of this case, HBS No. 156 004. This version was prepared by Professor David F. Hawkins and Jacob Cohen, Affiliate Professor of Accounting and Control at INSEAD. HBS cases are developed solely as the basis for class discussion. The company mentioned in the case is fictional. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management.
This document is authorized for use only by Kenneth Tuttle in Summer 2014 Strategic Cost Management (Online) taught by Yingxu Kuang from May 2014 to November 2014.
1) Which of the following is NOT an advantage of inflation targeting?
A) There is simplicity and clarity of the target.
B) Inflation targeting does not rely on a stable money inflation relationship.
C) There is an immediate signal on the achievement of the target.
D) Inflation targeting reduces the effects of inflation shocks.
2) Which of the following is NOT a disadvantage to inflation targeting?
A) There is a delayed signal about achievement of the target.
B) Inflation targets could impose a rigid rule on policymakers.
C) There is potential for larger output fluctuations.
D) There is a lack of transparency.
3) The decision by inflation targeters to choose inflation targets ________ zero reflects the concern of monetary policymakers that particularly ________ inflation can have substantial negative effects on real economic activity.
A) below; high
B) below; low
C) above; high
D) above; low
4) Inflation targets can increase the central bank”s flexibility in responding to declines in aggregate spending. Declines in aggregate ________ that cause the inflation rate to fall below the floor of the target range will automatically stimulate the central bank to ________ monetary policy without fearing that this action will trigger a rise in inflation expectations.
1) Explain what inflation targeting is. What are the advantages and disadvantages of this type of monetary policy strategy?
Monetary Policy with an Implicit Nominal Anchor
2) The type of monetary policy regime that the Federal Reserve has been following in recent years can best be described as
A) monetary targeting.
B) inflation targeting.
C) policy with an implicit nominal anchor.
D) exchange rate targeting.
3) Estimates suggest that, in the United States economy, it takes just over ________ for monetary policy to affect output and just over ________ for monetary policy to affect the inflation rate.
A) 1 year; 2 years
B) 2 years; 1 year
C) 1 year; 6 months
D) 6 months; 1 year
4) Which of the following is an advantage of the Fed”s “just do it” approach to monetary policy?
A) It does not rely on the money inflation relationship.
B) It is simplistic and has clarity.
C) There is increased accountability of central bankers.
D) There is an immediate signal if the target has been achieved.
1) According to the Taylor rule, the Fed should raise the federal funds interest rate when inflation ________ the Fed”s inflation target or when real GDP ________ the Fed”s output target.
A) rises above; drops below
B) drops below; drops below
C) rises above; rises above
D) drops below; rises above
2) Using Taylor”s rule, when the equilibrium real federal funds rate is 3 percent, the positive output gap is 2 percent, the target inflation rate is 1 percent, and the actual inflation rate is 2 percent, the nominal federal funds rate target should be
A) 5 percent.
B) 5.5 percent.
C) 6 percent.
D) 6.5 percent.
3) Using Taylor”s rule, when the equilibrium real federal funds rate is 2 percent, there is no output gap, the actual inflation rate is zero, and the target inflation rate is 2 percent, the nominal federal funds rate should be
A) 0 percent.
B) 1 percent.
C) 2 percent.
D) 3 percent.
4) According to the Taylor Principle, when the inflation rate rises, the nominal interest rate should be ________ by ________ than the inflation rate increase.
1)If the Taylor Principle is not followed and nominal interest rates are increased by less than the increase in the inflation rate, then real interest rates will ________ and monetary policy will be too ________.
A) rise; tight
B) rise; loose
C) fall; tight
D) fall; loose
2) The rate of inflation tends to remain constant when
A) the unemployment rate is above the NAIRU.
B) the unemployment rate equals the NAIRU.
C) the unemployment rate is below the NAIRU.
D) the unemployment rate increases faster than the NAIRU increases.
3) The rate of inflation increases when
A) the unemployment rate equals the NAIRU.
B) the unemployment rate exceeds the NAIRU.
C) the unemployment rate is less than the NAIRU.
D) the unemployment rate increases faster than the NAIRU increases.
4) Explain the Taylor rule, including the formula for setting the federal funds rate target, and the components of the formula. If the Fed were to use this rule, how many goals would it use to set monetary policy?
Central Banks” Response to Asset Price Bubbles: Lessons From The Subprime Crisis
1) When asset prices increase above their fundamental values it is called an ________.
A) asset price bubble
B) irrational bubble
C) asset price spike
D) irrational spike
2) Suppose interest rates are kept very low for a long time such that there is a spike in the amountof lending. Everything else held constant, this could cause ________ bubble.
A) an irrational exuberance
B) a credit driven
C) a stock
D) a debt driven
3) A credit driven bubble arises when ________ in lending causes ________ in asset prices which can cause ________ in lending.
Central Banks” Response to Asset Price Bubbles: Lessons From The Subprime Crisis
1) ________ bubble is driven entirely by unrealistic optimistic expectations.
A) An irrational exuberance
B) A credit driven
C) A stock
D) A debt driven
2) Everything else held constant, a credit drive bubble is generally considered to have the potential to cause ________ damage to an economy compared to an irrational exuberance bubble.
A) less
B) about the same amount of
C) more
D) either more, less, or the same amount of
3) A central bank has ________ chance to identify a credit driven bubble compared to an irrational exuberance bubble.
A) a greater
B) less of a
C) about the same level of a
D) a greater, less or about the same level of a
4) Which of the following is NOT an argument against using monetary policy to prick asset price bubbles?
A) The effect of increasing interest rates on asset prices is uncertain.
B) A bubble may only exist in some asset prices and monetary policy will affect all asset prices.
C) Using monetary policy to prick an asset price bubble may have adverse effect on the aggregate economy.
D) Even though credit drive bubbles are easier to identify, they are still relatively hard to identify.
1) In its earliest years, the Federal Reserve”s guiding principle for the conduct of monetary policy was known as the
A) real bills doctrine.
B) liberal liquidity doctrine.
C) free reserves doctrine.
D) quantity theory of money.
2) The guiding principle for the conduct of monetary policy that held that as long as loans were being made for “productive” purposes, then providing reserves to the banking system to make these loans would not be inflationary became known as the
A) free reserves doctrine.
B) Benjamin Strong doctrine.
C) efficient liquidity doctrine.
D) real bills doctrine.
3) The real bills doctrine was the guiding principle for the conduct of monetary policy during the
A) 1910s.
B) 1940s.
C) 1950s.
D) 1960s.
4) The Fed accidentally discovered open market operations in the early
1) The Fed accidentally discovered open market operations when A) it came to the rescue of failing banks in the early 1930s, and found that its purchases of bank loans injected reserves into the banking system.
B) it purchased securities for income following the 1920 1921 recession.
C) it attempted to slow inflation in 1919 by selling securities and found that its sales drained reserves from the banking system.
D) it reinterpreted a key provision of the Federal Reserve Act.
2) The Fed”s mistakes of the early 1930s were compounded by its decision to
A) raise reserve requirements in 1936 1937.
B) lower reserve requirements in 1936 1937.
C) raise the monetary base in 1936 1937.
D) lower the monetary base in 1936 1937.
3) During World War II, whenever interest rates would ________ and the price of bonds would begin to ________, the Fed would make open market purchases.
3) Targeting interest rates can be procyclical because
A) an increase in income increases interest rates, causing the Fed to buy bonds, increasing the monetary base and money supply, leading to further increases in income.
B) an increase in interest rates increases income, causing the Fed to buy bonds, increasing the monetary base and money supply, leading to further increases in income.
C) an increase in the monetary base increases the money supply, causing the Fed to buy bonds, increasing the monetary base and money supply, leading to further increases in income.
D) an increase in income increases the monetary base and money supply, causing the Fed to buy bonds to increase interest rates and income.
1) The Fed”s use of the ________ as an operating target in the 1970s resulted in ________ monetary policy.
A) federal funds rate; countercyclical
B) federal funds rate; procyclical
C) M1 money supply; countercyclical
D) M1 money supply; procyclical
2) In the 1970s, the Fed selected an interest rate as an operating target rather than a reserve aggregate primarily because it
A) had no interest in targeting a monetary aggregate, as evidenced by its unwillingness to target a reserve aggregate.
B) was still very concerned with achieving interest rate stability.
C) was committed to targeting free reserves.
D) was committed to the real bills doctrine.
3) The Fed operating procedures employed between 1979 and 1982 resulted in ________ swings in the federal funds rate and ________ swings in the M1 growth rate.
1) When the Fed acts as a lender of last resort, the type of lending it provides is
A) primary credit.
B) seasonal credit.
C) secondary credit.
D) installment credit.
2) The Fed”s discount lending is of three types: ________ is the most common category; ________ is given to a limited number of banks in vacation and agricultural areas; ________ is given to banks that have experienced severe liquidity problems.
A) seasonal credit; secondary credit; primary credit
B) secondary credit; seasonal credit; primary credit
C) primary credit; seasonal credit; secondary credit
1) The interest rate on secondary credit is set ________ basis points ________ the primary credit rate.
A) 100; above
B) 100; below
C) 50; above
D) 50; below
2) The interest rate for primary credit is usually set ________ basis points ________ the federal funds rate. In March 2008, this gap was changed to ________ basis points.
A) 50; below; 100
B) 100; above; 25
C) 100; below; 50
D) 50; above; 25
3) The interest rate on seasonal credit equals
A) the federal funds rate.
B) the primary credit rate.
C) the secondary credit rate.
D) an average of the federal funds rate and rates on certificates of deposits.
1) At its inception, the Federal Reserve was intended to be
A) the Treasury”s banker.
B) the issuer of government debt.
C) a lender of last resort.
D) a regulator of bank holding companies.
2) Much of the credit for prevention of a financial market meltdown after “Black Monday” (October 19, 1987) must be given to the Federal Reserve System and its chairman
A) Paul Volker.
B) Alan Blinder.
C) Arthur Burns.
D) Alan Greenspan.
3) A financial panic was averted in October 1987 following “Black Monday” when the Fed announced that
A) it was lowering the discount rate.
B) it would provide discount loans to any bank that would make loans to the security industry.
C) it stood ready to purchase common stocks to prevent a further slide in stock prices.
D) it was raising the discount rate.
4) The facility that was created in December of 2007 that banks can use to borrow from the Fed that has less of a stigma for banks compared to borrowing from the discount window is the ________.
1) The equivalent to the Federal Reserve”s discount rate in the European System of Central Banks is the
A) federal funds rate.
B) marginal lending rate.
C) deposit facility rate.
D) lombard rate.
2) The Federal Reserve ________ pay interest on reserves held on deposit. The European System of Central Banks ________ pay interest on reserves held on deposit.
A) does; does
B) does; does not
C) does not; does
D) does not; does not
3) Since the European Central Bank ________ interest on reserves, banks have a ________ cost of complying with reserve requirements when compared to banks complying with the reserve requirements of the Federal Reserve.
1) Everything else held constant, in the market for reserves, when the demand for federal funds intersects the reserve supply curve on the vertical section, increasing the discount rate
A) increases the federal funds rate.
B) lowers the federal funds rate.
C) has no effect on the federal funds rate.
D) has an indeterminate effect on the federal funds rate.
2) Everything else held constant, in the market for reserves, when the supply for federal funds intersects the reserve demand curve on the downward sloping section, decreasing the interest rate paid on excess reserves
A) increases the federal funds rate.
B) lowers the federal funds rate.
C) has no effect on the federal funds rate.
D) has an indeterminate effect on the federal funds rate.
3) Everything else held constant, in the market for reserves, increases in the discount rate affect the federal funds rate
A) when the funds rate is below the discount rate.
B) when the funds rate equals the discount rate.
C) when the demand for federal funds intersects the vertical section of the reserve supply curve.
1) In the market for reserves, if the federal funds rate is between the discount rate and the interest rate paid on excess reserves, an increase in the reserve requirement ________ the demand for reserves, ________ the federal funds rate, everything else held constant.
A) decreases; lowering
B) increases; lowering
C) increases; raising
D) decreases; raising
2) In the market for reserves, if the federal funds rate is between the discount rate and the interest rate paid on excess reserves, a ________ in the reserve requirement ________ the demand for reserves, raising the federal funds interest rate, everything else held constant.
A) rise; decreases
B) rise; increases
C) decline; increases
D) decline; decreases
3) In the market for reserves, if the federal funds rate is between the discount rate and the interest rate paid on excess reserves, a ________ in the reserve requirement increases the demand for reserves, ________ the federal funds interest rate, everything else held constant.
A) rise; lowering
B) decline; raising
C) decline; lowering
D) rise; raising
4) In the market for reserves, if the federal funds rate is between the discount rate and the interest rate paid on excess reserves, an increase in the reserve requirement ________ the demand of reserves and causes the federal funds interest rate to ________, everything else held constant.
1) In the market for reserves, if the federal funds rate is between the discount rate and the interest rate paid on excess reserves, an increase in the reserve requirement ________ the ________ for reserves and causes the federal funds interest rate to rise, everything else held constant.
A) decreases; demand
B) increases; demand
C) increases; supply
D) decreases; supply
2) In the market for reserves, if the federal funds rate is between the discount rate and the interest rate paid on excess reserves, a ________ in the reserve requirement ________ the demand for reserves, lowering the federal funds interest rate, everything else held constant.
A) rise; decreases
B) rise; increases
C) decline; increases
D) decline; decreases
3) In the market for reserves, if the federal funds rate is between the discount rate and the interest rate paid on excess reserves, a ________ in the reserve requirement decreases the demand for reserves, ________ the federal funds interest rate, everything else held constant.
1) In the market for reserves, if the federal funds rate is between the discount rate and the interest rate paid on excess reserves, a decline in the reserve requirement ________ the ________ curve of reserves and causes the federal funds interest rate to fall, everything else held constant.
A) decreases; demand
B) increases; demand
C) increases; supply
D) decreases; supply
2) In the market for reserves, if the federal funds rate is between the discount rate and the interest rate paid on excess reserves, a decline in the reserve requirement ________ the demand of reserves, ________ the federal funds rate, everything else held constant.
A) decreases; lowering
B) increases; lowering
C) increases; raising
D) decreases; raising
3) Suppose, at a given federal funds rate, there is an excess demand for reserves in the federal funds market. If the Fed wants the federal funds rate to stay at that level, then it should undertake an open market ________ of bonds, everything else held constant. If the Fed does nothing, however, the federal funds rate will ________.
A) sale; increase
B) purchase; increase
C) sale; decrease
D) purchase; decrease
4) Suppose, at a given federal funds rate, there is an excess supply of reserves in the federal funds market. If the Fed wants the federal funds rate to stay at that level, then it should undertake an open market ________ of bonds, everything else held constant. If the Fed does nothing, however, the federal funds rate will ________.
1) ________ are the most important monetary policy tool because they are the primary determinant of changes in the ________, the main source of fluctuations in the money supply.
A) Open market operations; monetary base
B) Open market operations; money multiplier
C) Changes in reserve requirements; monetary base
D) Changes in reserve requirements; money multiplier
2) Open market purchases raise the ________ thereby raising the ________.
A) money multiplier; money supply
B) money multiplier; monetary base
C) monetary base; money supply
D) monetary base; money multiplier
3) Open market purchases ________ reserves and the monetary base thereby ________ the money supply.
A) raise; lowering
B) raise; raising
C) lower; lowering
D) lower; raising
4) Open market sales shrink ________ thereby lowering ________.
A) the money multiplier; the money supply
B) the money multiplier; reserves and the monetary base
C) reserves and the monetary base; the money supply
1) Open market sales ________ reserves and the monetary base thereby ________ the money supply.
A) raise; lowering
B) raise; raising
C) lower; lowering
D) lower; raising
2) The two types of open market operations are
A) offensive and defensive.
B) dynamic and reactionary.
C) active and passive.
D) dynamic and defensive.
3) There are two types of open market operations: ________ open market operations are intended to change the level of reserves and the monetary base, and ________ open market operations are intended to offset movements in other factors that affect the monetary base.
A) defensive; dynamic
B) defensive; static
C) dynamic; defensive
D) dynamic; static
4) Open market operations intended to offset movements in noncontrollable factors (such as float) that affect reserves and the monetary base are called
1) When the Federal Reserve engages in a repurchase agreement to offset a withdrawal of Treasury funds from the Federal Reserve, the open market operation is said to be
A) defensive.
B) offensive.
C) dynamic.
D) reactionary.
2) The Federal Open Market Committee makes the Fed”s decisions on the purchase or sale of government securities, but these purchases or sales are executed by the Federal Reserve Bank of
A) Chicago.
B) Boston.
C) New York.
D) San Francisco.
3) The actual execution of open market operations is done at
A) the Board of Governors in Washington, D.C.
B) the Federal Reserve Bank of New York.
C) the Federal Reserve Bank of Philadelphia.
D) the Federal Reserve Bank of Boston.
4) If float is predicted to decrease because of unseasonably good weather, the manager of thetrading desk at the Federal Reserve Bank of New York will likely conduct a ________ open market ________ of securities.
1) If float is predicted to increase because of bad weather, the manager of the trading desk at the New York Fed bank will likely conduct ________ open market operations to ________ reserves.
A) defensive; inject
B) defensive; drain
C) dynamic; inject
D) dynamic; drain
2) If float is predicted to decrease because of good weather, the manager of the trading desk at the New York Fed bank will likely conduct ________ open market operations to ________ reserves.
A) defensive; inject
B) defensive; drain
C) dynamic; inject
D) dynamic; drain
3) If Treasury deposits at the Fed are predicted to increase, the manager of the trading desk at the New York Fed bank will likely conduct ________ open market operations to ________ reserves.
A) defensive; inject
B) defensive; drain
C) dynamic; inject
D) dynamic; drain
4) If Treasury deposits at the Fed are predicted to ________, the manager of the trading desk at the New York Fed bank will likely conduct ________ open market operations to ________ reserves.
1) If Treasury deposits at the Fed are predicted to fall, the manager of the trading desk at the New York Fed bank will likely conduct ________ open market operations to ________ reserves.
A) defensive; inject
B) defensive; drain
C) dynamic; inject
D) dynamic; drain
2) If Treasury deposits at the Fed are predicted to ________, the manager of the trading desk at the New York Fed bank will likely conduct ________ open market operations to ________ reserves.
A) rise; defensive; drain
B) fall; defensive; drain
C) rise; dynamic; inject
D) fall; dynamic; drain
3) If the Fed expects currency holdings to rise, it conducts open market ________ to offset the expected ________ in reserves.
A) purchases; increase
B) purchases; decrease
C) sales; increase
D) sales; decrease
4) If the Fed expects currency holdings to fall, it conducts open market ________ to offset the expected ________ in reserves.
1) If the banking system has a large amount of reserves, many banks will have excess reserves to lend and the federal funds rate will probably ________; if the level of reserves is low, few banks will have excess reserves to lend and the federal funds rate will probably ________.
A) fall; fall
B) fall; rise
C) rise; fall
D) rise; rise
2) The Federal Reserve will engage in a repurchase agreement when it wants to ________ reserves ________ in the banking system.
A) increase; permanently
B) increase; temporarily
C) decrease; temporarily
D) decrease; permanently
3) If the Fed wants to temporarily inject reserves into the banking system, it will engage in
A) a repurchase agreement.
B) a matched sale purchase transaction.
C) a reverse repurchase agreement.
D) an open market sale.
4) The Fed can offset the effects of an increase in float by engaging in
1) Discount policy affects the money supply by affecting the volume of ________ and the ________.
A) excess reserves; monetary base
B) borrowed reserves; monetary base
C) excess reserves; money multiplier
D) borrowed reserves; money multiplier
2) The discount rate is
A) the interest rate the Fed charges on loans to banks.
B) the price the Fed pays for government securities.
C) the interest rate that banks charge their most preferred customers.
D) the price banks pay the Fed for government securities.
3) The most common type of discount lending that the Fed extends to banks is called
A) seasonal credit.
B) secondary credit.
C) primary credit.
D) installment credit.
4) The most common type of discount lending, ________ credit loans, are intended to help healthy banks with short term liquidity problems that often result from temporary deposit outflows.
1) Assuming initially that r = 10%, c = 40%, and e = 0, an decrease in c to 30% causes the M1 money multiplier to ________, everything else held constant.
A) increase from 2.8 to 3.25
B) decrease from 3.25 to 2.8
C) increase from 2.8 to 3.5
D) decrease from 3.5 to 2.8
2) Every thing else held constant, a decrease in the excess reserves ratio causes the M1 money multiplier to ________ and the money supply to ________.
A) decrease; increase
B) increase; increase
C) decrease; decrease
D) increase; decrease
3) Everything else held constant, an increase in the excess reserves ratio causes the M1 money multiplier to ________ and the money supply to ________.
A) decrease; increase
B) increase; increase
C) decrease; decrease
D) increase; decrease
4) Assuming initially that r = 15%, c = 40%, and e = 5%, a decrease in e to 0% causes the M1 money multiplier to ________, everything else held constant.
1) Assuming initially that r = 15%, c = 40%, and e = 5%, an increase in e to 10% causes the M1 money multiplier to ________, everything else held constant.
A) increase from 2.15 to 2.33
B) decrease from 2.33 to 2.15
C) increase from 1.54 to 1.67
D) decrease from 1.67 to 1.54
2) The excess reserves ratio is ________ related to expected deposit outflows, and is ________ related to the market interest rate.
A) negatively; negatively
B) negatively; positively
C) positively; negatively
D) positively; positively
3) The money supply is ________ related to expected deposit outflows, and is ________ related to the market interest rate.
A) negatively; negatively
B) negatively; positively
C) positively; negatively
D) positively; positively
4) The money multiplier is
A) negatively related to high powered money.
B) positively related to the excess reserves ratio.
C) negatively related to the required reserve ratio.
D) positively related to holdings of excess reserves.
1) Special Drawing Rights (SDRs) are issued to governments by the ________ to settle international debts and have replaced ________ in international transactions.
A) Federal Reserve System; gold
B) Federal Reserve System; dollars
C) International Monetary Fund; gold
D) International Monetary Fund; dollars
2) When the Treasury acquires gold or SDRs, it issues certificates to the ________, which are a claim on the gold or SDRs, and in turn is credited with deposit balances at the ________.
A) Federal Reserve System; Fed
B) Federal Reserve System; IMF
C) International Monetary Fund; Fed
D) International Monetary Fund; IMF
3) Which of the following are not assets on the Fed”s balance sheet?
A) Discount loans
B) U.S. Treasury deposits
C) Cash items in the process of collection
D) U.S. Treasury bills
4) Which of the following are not assets on the Fed”s balance sheet?
1) Which of the following are not liabilities on the Fed”s balance sheet?
A) Discount loans
B) Bank deposits
C) Deferred availability cash items
D) U.S. Treasury deposits
2) When the Fed purchases artwork to decorate the conference room at the Federal Reserve Bank of Kansas City,
A) reserves rise, but the monetary base falls.
B) reserves fall.
C) currency in circulation falls.
D) the monetary base rises.
3) A Fed purchase of gold, SDRs, a deposit denominated in a foreign currency or any other asset is just an open market ________ of these assets, ________ the monetary base.
A) purchase; raising
B) sale; raising
C) purchase; lowering
D) sale; lowering
4) An increase in Treasury deposits at the Fed causes
A) the monetary base to increase.
B) the monetary base to decrease.
C) Fed assets to increase but has no effect on the monetary base.
D) Fed assets to decrease but has no effect on the monetary base.
1) An increase in U.S. Treasury deposits at the Fed reduces both ________ and the ________.
A) reserves; monetary base
B) Fed liabilities; money multiplier
C) Fed assets; monetary base
D) Fed assets; money multiplier
2) U.S. Treasury deposits at the Fed are ________ for the Fed but ________ for the Treasury. Thus an increase in U.S. Treasury deposits ________ the monetary base.
A) a liability; an asset; increases
B) a liability; an asset; decreases
C) an asset; a liability; increases
D) an asset; a liability; decreases
3) An increase in which of the following leads to a decline in the monetary base?
A) Float
B) Discount loans
C) Foreign deposits at the Fed
D) SDRs
4) Suppose, while cleaning out its closets, a worker at the Federal Reserve bank branch in Memphis discovers a painting of Elvis (medium: acrylic on velvet) that used to grace the walls of the conference room. Suppose further that, at a public auction, the bank sells the painting for $19.95. This sale will cause ________ in the monetary base, everything else held constant.
1) Suppose the Bank of China permanently decreases its purchases of U.S. government bonds and, instead, holds more dollars on deposit at the Federal Reserve. Everything else held constant, open market ________ would be the appropriate monetary policy action for the Fed to take to offset the expected ________ in the monetary base in the United States.
A) purchase; decrease
B) purchase; increase
C) sale; decrease
D) sale; increase
The M2 Money Multiplier
2) The equation that represents M2 in the model of the money supply process is
A) M2 = C + D.
B) M2 = C + D + T MMF.
C) M2 = C + D T + MMF.
D) M2 = C + D + T + MMF.
3) In the model of the money supply process for M2, the relationship between checkable deposits and the M2 money supply is represented by
C) positively related to the required reserve ratio.
D) positively related to the excess reserves ratio.
3) Everything else held constant, an increase in the currency ratio will mean ________ in the M2 money multiplier and ________ in the M2 money supply.
A) an increase; an increase
B) an increase; a decrease
C) a decrease; an increase
D) a decrease; a decrease
4) Everything else held constant, a decrease in the currency ratio will mean ________ in the M1 money multiplier and ________ in the M2 money multiplier.
1) Everything else held constant, an increase in the required reserve ratio will mean ________ in the M2 money multiplier and ________ in the M2 money supply.
A) an increase; an increase
B) an increase; a decrease
C) a decrease; an increase
D) a decrease; a decrease
2) Everything else held constant, an increase in the required reserve ratio will result in ________ in M1 and ________ in M2..
A) an increase; an increase
B) an increase; a decrease
C) a decrease; an increase
D) a decrease; a decrease
3) Everything else held constant, an increase in the time deposit ratio will mean ________ in the M2 money multiplier and ________ in the M2 money supply.
A) an increase; an increase
B) an increase; a decrease
C) a decrease; an increase
D) a decrease; a decrease
4) Everything else held constant, an increase in the time deposit ratio will result in ________ in the M1 money multiplier and ________ in the M2 money multiplier.
1) Everything else held constant, an increase in the money market fund ratio will mean ________ in the M2 money multiplier and ________ in the M2 money supply.
A) an increase; an increase
B) an increase; a decrease
C) a decrease; an increase
D) a decrease; a decrease
2) Everything else held constant, an increase in the money market fund ratio will result in ________ in the M1 money multiplier and ________ in the M2 money multiplier.
A) an increase; an increase
B) no change; an increase
C) a decrease; a decrease
D) no change; a decrease
3) Everything else held constant, an increase in the excess reserve ratio will mean ________ in the M2 money multiplier and ________ in the M2 money supply.
1) Everything else held constant, an increase in the excess reserve ratio will mean ________ in the M1 money multiplier and ________ in the M2 money multiplier.
A) an increase; an increase
B) no change; an increase
C) a decrease; a decrease
D) no change; a decrease
Explaining the Behavior of the Currency Ratio
2) Factors causing an increase in currency holdings include
A) an increase in the interest rates paid on checkable deposits.
B) an increase in the cost of acquiring currency.
C) a decrease in bank panics.
D) an increase in illegal activity.
3) Part of the increase in currency holdings in the 1960s and 1970s can be attributed to
A) increases in income tax rates.
B) the switch from progressive to proportional income taxes.
C) the adoption of regressive taxes.
D) bracket creep due to inflation and progressive income taxes.
1) Everything else held constant, an increase in wealth will cause the holdings of checkable deposits to the holdings of currency to ________ and the currency ratio will ________.
A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease
2) Everything else held constant, an increase in the interest rate paid on checkable deposits will cause ________ in the amount of checkable deposits held relative to currency holdings and ________ in the currency ratio.
A) an increase; an increase
B) an increase; a decrease
C) a decrease; an increase
D) a decrease; a decrease
3) The increase in the availability of ATM”s has caused the cost of acquiring currency to ________ which will cause the currency ratio to ________, everything else held constant.
A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease
4) The steepest increase in the currency ratio since 1892 occurred during
1) The Fed uses three policy tools to manipulate the money supply: ________, which affect reserves and the monetary base; changes in ________, which affect the monetary base; and changes in ________, which affect the money multiplier.
A) open market operations; borrowed reserves; margin requirements
B) open market operations; borrowed reserves; reserve requirements
C) borrowed reserves; open market operations; margin requirements
D) borrowed reserves; open market operations; reserve requirements
2) The Fed uses three policy tools to manipulate the money supply: open market operations, which affect the ________; changes in borrowed reserves, which affect the ________; and changes in reserve requirements, which affect the ________.
A) money multiplier; monetary base; monetary base
B) monetary base; money multiplier; monetary base
C) monetary base; monetary base; money multiplier
D) money multiplier; money multiplier; monetary base
3) The interest rate charged on overnight loans of reserves between banks is the
A) prime rate.
B) discount rate.
C) federal funds rate.
D) Treasury bill rate.
4) The primary indicator of the Fed”s stance on monetary policy is
1) In the market for reserves, when the federal funds rate is above the interest rate paid on excess reserves, the demand curve for reserves is ________.
A) vertical
B) horizontal
C) positively sloped
D) negatively sloped
2) When the federal funds rate equals the interest rate paid on excess reserves ________.
A) the supply curve of reserves is vertical
B) the supply curve of reserves is horizontal
C) the demand curve for reserves is vertical
D) the demand curve for reserves is horizontal
3) Which of the following is NOT an argument for the Federal Reserve paying interest on excess reserve holdings?
A) Paying interest reduces the effective tax on deposits.
B) Paying interest will help in the implementation of monetary policy.
C) Paying interest will help the Federal Reserve have more control of the amount of discount loans.
D) Paying interest increases the capacity of the Fed”s balance sheet which will make it easier to address financial crises.
1) In the market for reserves, when the federal funds interest rate is below the discount rate, the supply curve of reserves is
A) vertical.
B) horizontal.
C) positively sloped.
D) negatively sloped.
2) When the federal funds rate equals the discount rate
A) the supply curve of reserves is vertical.
B) the supply curve of reserves is horizontal.
C) the demand curve for reserves is vertical.
D) the demand curve for reserves is horizontal.
3) In the market for reserves, if the federal funds rate is above the interest rate paid on excess reserves, then an open market ________ the supply of reserves, raising the federal funds interest rate, everything else held constant.
A) sale decreases
B) sale increases
C) purchase increases
D) purchase decreases
4) In the market for reserves, if the federal funds rate is above the interest rate paid on excess reserves, an open market purchase ________ the ________ of reserves which causes the federal funds rate to fall, everything else held constant.
1) Suppose on any given day there is an excess demand of reserves in the federal funds market. If the Federal Reserve wishes to keep the federal funds rate at its current level, then the appropriate action for the Federal Reserve to take is a ________ open market ________, everything else held constant.
A) defensive; sale
B) defensive; purchase
C) dynamic; sale
D) dynamic; purchase
2) In the market for reserves, if the federal funds rate is above the interest rate paid on excess reserves, an open market purchase ________ the supply of reserves and causes the federal funds interest rate to ________, everything else held constant.
A) decreases; fall
B) increases; fall
C) increases; rise
D) decreases; rise
3) Suppose on any given day the prevailing equilibrium federal funds rate is above the Federal Reserve”s federal funds target rate. If the Federal Reserve wishes for the federal funds rate to be at their target level, then the appropriate action for the Federal Reserve to take is a ________ open market ________, everything else held constant.
1) Everything else held constant, in the market for reserves, when the federal funds rate is 3%, increasing the interest rate paid on excess reserves from 1% to 2%
A) lowers the federal funds rate.
B) raises the federal funds rate
C) has no effect on the federal funds rate.
D) has an indeterminate effect on the federal funds rate.
2) Everything else held constant, in the market for reserves, when the federal funds rate is 5%, lowering the discount rate from 5% to 4%
A) lowers the federal funds rate.
B) raises the federal funds rate.
C) has no effect on the federal funds rate.
D) has an indeterminate effect on the federal funds rate.
3) Everything else held constant, in the market for reserves, when the federal funds rate is 1%, increasing the interest rate paid on excess reserves from 1% to 2%
A) lowers the federal funds rate.
B) raises the federal funds rate.
C) has no effect on the federal funds rate.
D) has an indeterminate effect on the federal funds rate.
1) Everything else held constant, in the market for reserves, when the federal funds rate is 3%, raising the discount rate from 5% to 6%
A) lowers the federal funds rate.
B) raises the federal funds rate.
C) has no effect on the federal funds rate.
D) has an indeterminate effect on the federal funds rate.
2) Everything else held constant, in the market for reserves, when the federal funds rate is 3%, lowering the interest rate paid on excess reserves rate from 2% to 1%
A) lowers the federal funds rate.
B) raises the federal funds rate.
C) has no effect on the federal funds rate.
D) has an indeterminate effect on the federal funds rate.
3) Everything else held constant, in the market for reserves, when the federal funds rate equals the discount rate, lowering he discount rate
A) increases the federal funds rate.
B) lowers the federal funds rate.
C) has no effect on the federal funds rate.
D) has an indeterminate effect of the federal funds rate.
1) Everything else held constant, in the market for reserves, when the federal funds rate equals the interest rate paid on excess reserves, raising the interest rate paid on excess reserves
A) increases the federal funds rate.
B) lowers the federal funds rate.
C) has no effect on the federal funds rate.
D) has an indeterminate effect of the federal funds rate.
2) Everything else held constant, in the market for reserves, when the demand for federal funds intersects the reserve supply curve along the horizontal section, increasing the discount rate
A) increases the federal funds rate.
B) lowers the federal funds rate.
C) has no effect on the federal funds rate.
D) has an indeterminate effect on the federal funds rate.
3) Everything else held constant, in the market for reserves, when the supply for federal funds intersects the reserve demand curve along the horizontal section, lowering the interest rate paid on excess reserves
A) increases the federal funds rate.
B) lowers the federal funds rate.
C) has no effect on the federal funds rate.
D) has an indeterminate effect of the federal funds rate.
1) When the Fed supplies the banking system with an extra dollar of reserves, deposits increase by more than one dollar a process called
A) extra deposit creation.
B) multiple deposit creation.
C) expansionary deposit creation.
D) stimulative deposit creation.
2) When the Fed supplies the banking system with an extra dollar of reserves, deposits ________ by ________ than one dollar a process called multiple deposit creation.
A) increase; less
B) increase; more
C) decrease; less
D) decrease; more
3) If the required reserve ratio is equal to 10 percent, a single bank can increase its loans up to a maximum amount equal to
A) its excess reserves.
B) 10 times its excess reserves.
C) 10 percent of its excess reserves.
D) its total reserves.
4) In the simple deposit expansion model, if the Fed purchases $100 worth of bonds from a bank that previously had no excess reserves, the bank can now increase its loans by
A) $10.
B) $100.
C) $100 times the reciprocal of the required reserve ratio.
1) The formula for the simple deposit multiplier can be expressed as
A) ?R = 1r × ?T
B) ?D = 1r × ?R
C) ?r = 1R × ?T
D) ?R = 1r × ?D
2) In the simple model of multiple deposit creation in which banks do not hold excess reserves, the increase in checkable deposits equals the product of the change in excess reserves and the
A) reciprocal of the excess reserve ratio.
B) simple deposit expansion multiplier.
C) reciprocal of the simple deposit multiplier.
D) discount rate.
3) The simple deposit multiplier can be expressed as the ratio of the
A) change in reserves in the banking system divided by the change in deposits.
B) change in deposits divided by the change in reserves in the banking system.
C) required reserve ratio divided by the change in reserves in the banking system.
D) change in deposits divided by the required reserve ratio.
4) If reserves in the banking system increase by $100, then checkable deposits will increase by $1000 in the simple model of deposit creation when the required reserve ratio is
A) 0.01.
B) 0.10.
C) 0.05.
D) 0.20.
5) If reserves in the banking system increase by $100, then checkable deposits will increase by $500 in the simple model of deposit creation when the required reserve ratio is
1) In the simple deposit expansion model, if the required reserve ratio is 20 percent and the Fed increases reserves by $100, checkable deposits can potentially expand by
A) $100.
B) $250.
C) $500.
D) $1,000.
2) In the simple deposit expansion model, if the required reserve ratio is 10 percent and the Fed increases reserves by $100, checkable deposits can potentially expand by
A) $100.
B) $250.
C) $500.
D) $1,000.
3) In the simple deposit expansion model, an expansion in checkable deposits of $1,000 when the required reserve ratio is equal to 20 percent implies that the Fed
A) sold $200 in government bonds.
B) sold $500 in government bonds.
C) purchased $200 in government bonds.
D) purchased $500 in government bonds.
4) In the simple deposit expansion model, an expansion in checkable deposits of $1,000 when the required reserve ratio is equal to 10 percent implies that the Fed
1) In the simple deposit expansion model, a decline in checkable deposits of $1,000 when the required reserve ratio is equal to 20 percent implies that the Fed
A) sold $200 in government bonds.
B) sold $500 in government bonds.
C) purchased $200 in government bonds.
D) purchased $500 in government bonds.
2) In the simple deposit expansion model, a decline in checkable deposits of $1,000 when the required reserve ratio is equal to 10 percent implies that the Fed
A) sold $1,000 in government bonds.
B) sold $100 in government bonds.
C) purchased $1,000 in government bonds.
D) purchased $100 in government bonds.
3) In the simple deposit expansion model, a decline in checkable deposits of $500 when the required reserve ratio is equal to 10 percent implies that the Fed
A) sold $500 in government bonds.
B) sold $50 in government bonds.
C) purchased $50 in government bonds.
D) purchased $500 in government bonds.
4) In the simple deposit expansion model, a decline in checkable deposits of $500 when the required reserve ratio is equal to 20 percent implies that the Fed
1) If reserves in the banking system increase by $100, then checkable deposits will increase by $667 in the simple model of deposit creation when the required reserve ratio is
A) 0.01.
B) 0.05.
C) 0.15.
D) 0.20.
2) If reserves in the banking system increase by $100, then checkable deposits will increase by $100 in the simple model of deposit creation when the required reserve ratio is
A) 0.01.
B) 0.10.
C) 0.20.
D) 1.00.
3) If reserves in the banking system increase by $100, then checkable deposits will increase by $2,000 in the simple model of deposit creation when the required reserve ratio is
A) 0.01.
B) 0.05.
C) 0.10.
D) 0.20.
4) If reserves in the banking system increase by $200, then checkable deposits will increase by $500 in the simple model of deposit creation when the required reserve ratio is
1) If a bank has excess reserves of $10,000 and demand deposit liabilities of $80,000, and if the reserve requirement is 20 percent, then the bank has actual reserves of
A) $16,000.
B) $20,000.
C) $26,000.
D) $36,000.
2) If a bank has excess reserves of $20,000 and demand deposit liabilities of $80,000, and if the reserve requirement is 20 percent, then the bank has total reserves of
A) $16,000.
B) $20,000.
C) $26,000.
D) $36,000.
3) If a bank has excess reserves of $5,000 and demand deposit liabilities of $80,000, and if the reserve requirement is 20 percent, then the bank has actual reserves of
1) If a bank has excess reserves of $15,000 and demand deposit liabilities of $80,000, and if the reserve requirement is 20 percent, then the bank has total reserves of
A) $11,000.
B) $21,000.
C) $31,000.
D) $41,000.
2) If a bank has excess reserves of $4,000 and demand deposit liabilities of $100,000, and if the reserve requirement is 15 percent, then the bank has actual reserves of
A) $17,000.
B) $19,000.
C) $24,000.
D) $29,000.
3) If a bank has excess reserves of $4,000 and demand deposit liabilities of $100,000, and if the reserve requirement is 10 percent, then the bank has actual reserves of
A) $14,000.
B) $19,000.
C) $24,000.
D) $29,000.
4) If a bank has excess reserves of $7,000 and demand deposit liabilities of $100,000, and if the reserve requirement is 15 percent, then the bank has actual reserves of
1) A bank has no excess reserves and demand deposit liabilities of $100,000 when the required reserve ratio is 20 percent. If the reserve ratio is raised to 25 percent, the bank”s excess reserves will now be
A) $5,000.
B) $1,000.
C) $1,000.
D) $5,000.
2) A bank has excess reserves of $1,000 and demand deposit liabilities of $80,000 when the reserve requirement is 20 percent. If the reserve requirement is lowered to 10 percent, the bank”s excess reserves will be
A) $1,000.
B) $8,000.
C) $9,000.
D) $17,000.
3) A bank has excess reserves of $1,000 and demand deposit liabilities of $80,000 when the reserve requirement is 25 percent. If the reserve requirement is lowered to 20 percent, the bank”s excess reserves will be
A) $1,000.
B) $5,000.
C) $8,000.
D) $9,000.
4) Decisions by depositors to increase their holdings of ________, or of banks to hold ________ will result in a smaller expansion of deposits than the simple model predicts.
Assume that no banks hold excess reserves, and the public holds no currency. If a bank sells a $100 security to the Fed, explain what happens to this bank and two additional steps in the deposit expansion process, assuming a 10% reserve requirement. How much do deposits and loans increase for the banking system when the process is completed?
Bank A first changes a security for reserves, and then lends the reserves, creating loans. It receives $100 in reserves from the sale of securities. Since all of these reserve will be excess reserves (there was no change in checkable deposits), the bank will loan out all $100. The $100 will then be deposited into Bank B. This bank now has a change in reserves of $100, of which $90 is excess reserves.
Bank B will loan out this $90, which will be deposited into Bank C. Bank C now has an increase in reserves of $90, $81 of which is excess reserves.
Bank C will loan out this $81 dollars and the process will continue until there are no more excess reserves in the banking system. For the banking system, both loans and deposits increase by $1000.
1) In the model of the money supply process, the bank”s role in influencing the money supply process is represented by
A) only the excess reserve ratio.
B) both the excess reserve ratio and the market interest rate.
C) only the currency ratio.
D) only borrowed reserves.
The Money Multiplier
2) Models describing the determination of the money supply and the Fed”s role in this process normally focus on ________ rather than ________, since Fed actions have a more predictable effect on the former.
A) reserves; the monetary base
B) reserves; high powered money
C) the monetary base; high powered money
D) the monetary base; reserves
3) The Fed can exert more precise control over ________ than it can over ________.
1) An increase in the monetary base that goes into ________ is not multiplied, while an increase that goes into ________ is multiplied.
A) deposits; currency
B) excess reserves; currency
C) currency; excess reserves
D) currency; deposits
2) An increase in the monetary base that goes into currency is ________, while an increase that goes into deposits is ________.
A) multiplied; multiplied
B) not multiplied; multiplied
C) multiplied; not multiplied
D) not multiplied; not multiplied
3) If the Fed injects reserves into the banking system and they are held as excess reserves, then the money supply
A) increases by only the initial increase in reserves.
B) increases by only one half the initial increase in reserves.
C) increases by a multiple of the initial increase in reserves.
D) does not change.
4) If the Fed injects reserves into the banking system and they are held as excess reserves, then the monetary base ________ and the money supply ________.
1) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable deposits are $800 billion, and excess reserves total $0.8 billion, then the money supply is ________ billion.
A) $8000
B) $1200
C) $1200.8
D) $8400
2) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable deposits are $800 billion, and excess reserves total $0.8 billion, then the M1 money multiplier is
A) 2.5.
B) 1.67.
C) 2.0.
D) 0.601.
3) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable deposits are $800 billion, and excess reserves total $0.8 billion, then the currency ratio is
A) 0.25.
B) 0.50.
C) 0.40.
D) 0.05.
4) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable deposits are $800 billion, and excess reserves total $0.8 billion, then the excess reserves checkable deposit ratio is
1) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable deposits are $800 billion, and excess reserves total $0.8 billion, then the monetary base is
A) $480 billion.
B) $480.8 billion.
C) $80 billion.
D) $80.8 billion.
2) If the required reserve ratio is 15 percent, currency in circulation is $400 billion, checkable deposits are $800 billion, and excess reserves total $0.8 billion, then the M1 money multiplier is
A) 2.5.
B) 1.67.
C) 2.3.
D) 0.651.
3) If the required reserve ratio is 5 percent, currency in circulation is $400 billion, checkable deposits are $800 billion, and excess reserves total $0.8 billion, then the M1 money multiplier is
A) 2.5.
B) 2.72.
C) 2.3.
D) 0.551.
4) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable deposits are $1000 billion, and excess reserves total $1 billion, then the money supply is ________ billion.
1) If the required reserve ratio is one third, currency in circulation is $300 billion, and checkable deposits are $900 billion, then the level of excess reserves in the banking system is
A) $300 billion.
B) $30 billion.
C) $3 billion.
D) 0.
2) If the required reserve ratio is one third, currency in circulation is $300 billion, and checkable deposits are $900 billion, then the monetary base is
A) $300 billion.
B) $600 billion.
C) $333 billion.
D) $667 billion.
3) Everything else held constant, an increase in the required reserve ratio on checkable deposits will cause
A) the money supply to rise.
B) the money supply to remain constant.
C) the money supply to fall.
D) checkable deposits to rise.
4) Everything else held constant, a decrease in the required reserve ratio on checkable deposits will mean
A) a decrease in the money supply.
B) an increase in the money supply.
C) a decrease in checkable deposits.
D) an increase in discount loans.
5) Everything else hed constant, an increase in the required reserve ratio on checkable deposits causes the M1 money multiplier to ________ and the money supply to ________.
1) Everything else held constant, a decrease in the required reserve ratio on checkable deposits causes the M1 money multiplier to ________ and the money supply to ________.
A) decrease; increase
B) increase; increase
C) decrease; decrease
D) increase; decrease
2) Assuming initially that r = 10%, c = 40%, and e = 0, an increase in r to 15% causes the M1 money multiplier to ________, everything else held constant.
A) increase from 2.55 to 2.8
B) decrease from 2.8 to 2.55
C) increase from 1.82 to 2
D) decrease from 2 to 1.82
3) Assuming initially that r = 10%, c = 40%, and e = 0, a decrease in r to 5% causes the M1 money multiplier to ________, everything else held constant.
A) increase from 2.8 to 3.11
B) decrease from 3.11 to 2.8
C) increase from 2 to 2.22
D) decrease from 2.22 to 2
4) Everything else held constant, an increase in the currency checkable deposit ratio will mean
A) an increase in currency in circulation and an increase in the money supply.
B) an increase in money supply but no change in reserves.
C) a decrease in the money supply.
D) an increase in currency in circulation but no change in the money supply.
1) Everything else held constant, a decrease in the currency checkable deposit ratio will mean
A) an increase in currency in circulation and an increase in the money supply.
B) an increase in money supply.
C) a decrease in the money supply.
D) an increase in currency in circulation but no change in the money supply.
2) Everything else held constant, an increase in the currency ratio causes the M1 money multiplier to ________ and the money supply to ________.
A) decrease; increase
B) increase; decrease
C) decrease; decrease
D) increase; increase
3) Everything else held constant, a decrease in the currency ratio causes the M1 money multiplier to ________ and the money supply to ________.
A) decrease; increase
B) increase; increase
C) decrease; decrease
D) increase; decrease
4) Assuming initially that r = 10%, c = 40%, and e = 0, an increase in c to 50% causes the M1 money multiplier to ________, everything else held constant.
1) Members of Congress are able to influence monetary policy, albeit indirectly, through their ability to
A) withhold appropriations from the Board of Governors.
B) withhold appropriations from the Federal Open Market Committee.
C) propose legislation that would force the Fed to submit budget requests to Congress, as must other government agencies.
D) instruct the General Accounting Office to audit the foreign exchange market functions of the Federal Reserve.
2) Explain two concepts of central bank independence. Is the Fed politically independent? Why do economists think central bank independence is important?
3) Why does the Federal Reserve Bank of New York play a special role within the Federal Reserve System?
4) Who are the voting members of the Federal Open Market Committee and why is this committee important? Where does the power lie within this committee?
1) Which of the following statements comparing the European System of Central Banks and the Federal Reserve System is TRUE?
A) The budgets of the Federal Reserve Banks are controlled by the Board of Governors, while the National Central Banks control their own budgets and the budget of the European Central Bank.
B) The European Central Bank has similar power over the National Central Banks when compared to the level of power the Board of Governors has over the Federal Reserve Banks.
C) Just like the Federal Reserve System, monetary operations are centralized in the European System of Central Banks with the European Central Bank.
D) The European Central Bank”s involvement in supervision and regulation of financial institutions is comparable to the Board of Governors” involvement.
2) The Governing Council usually meets ________ times a year.
A) four
B) six
C) eight
D) twelve
3) In the Governing Council, the decision of what policy to implement is made by
A) majority vote of the Executive Board members.
B) majority vote of the heads of the National Banks.
C) consensus.
D) majority vote of all members of the Governing Council.
A) the Fed is more independent than the European Central Bank.
B) the European Central Bank is more independent than the Fed.
C) the trend in industrialized nations has been to reduce central bank independence.
D) the Bank of England has the longest tradition of independence of any central bank in the world.
2) The trend in recent years is that more and more governments
A) have been granting greater independence to their central banks.
B) have been reducing the independence of their central banks to make them more accountable for poor economic performance.
C) have mandated that their central banks focus on controlling inflation.
D) have required their central banks to cooperate more with their Ministers of Finance.
3) Which of the following statements about central bank structure and independence are true?
A) In recent years, with the exception of the Bank of England and the Bank of Japan, most countries have reduced the independence of their central banks, subjecting them to greater democratic control.
B) Before the Bank of England was granted greater independence, the Federal Reserve was the most independent of the world”s central banks.
C) Both theory and experience suggest that more independent central banks produce better monetary policy.
D) While the European Central Bank is independent, it is not as independent as the Federal Reserve.
1) The theory of bureaucratic behavior suggests that the objective of a bureaucracy is to maximize
A) the public”s welfare.
B) profits.
C) its own welfare.
D) conflict with the executive and legislative branches of government.
2) The theory of bureaucratic behavior when applied to the Fed helps to explain why the Fed
A) is supportive of congressional attempts to limit the central bank”s autonomy.
B) is so secretive about the conduct of future monetary policy.
C) sought less control over banks in the 1980s.
D) is willing to take on powerful groups that may threaten its autonomy.
3) Compared to the Federal Reserve, the European Central Bank is less transparent because
A) the European Central Bank doesn”t publicly release its inflation rate target for the European Monetary Union while the Federal Reserve publicly releases its inflation rate target for the United States.
B) the Federal Reserve holds a press conference after a policy meeting while the European Central Bank makes no public statement after its policy meetings.
C) the Federal Reserve publicly releases the minutes 3 weeks after the meetings while theEuropean Central bank waits 20 years to publicly release its minutes.
D) the European Central Bank does not publicly release its economic forecasts while the Federal Reserve immediately releases its economic forecasts to the public.
1) Suppose that from a new checkable deposit, First National Bank holds two million dollars in vault cash, eight million dollars on deposit with the Federal Reserve, and one million dollars in required reserves. Given this information, we can say First National Bank has ________ million dollars in excess reserves.
A) three
B) nine
C) ten
D) eleven
2) Suppose that from a new checkable deposit, First National Bank holds two million dollars in vault cash, eight million dollars on deposit with the Federal Reserve, and one million dollars in required reserves. Given this information, we can say First National Bank faces a required reserve ratio of ________ percent.
A) ten
B) twenty
C) eighty
D) ninety
3) Suppose that from a new checkable deposit, First National Bank holds two million dollars in vault cash, eight million dollars on deposit with the Federal Reserve, and nine million dollars in excess reserves. Given this information, we can say First National Bank has ________ million dollars in required reserves.
1) Suppose that from a new checkable deposit, First National Bank holds two million dollars in vault cash, eight million dollars on deposit with the Federal Reserve, and nine million dollars in excess reserves. Given this information, we can say First National Bank faces a required reserve ratio of ________ percent.
A) ten
B) twenty
C) eighty
D) ninety
2) Suppose that from a new checkable deposit, First National Bank holds eight million dollars on deposit with the Federal Reserve, one million dollars in required reserves, and faces a required reserve ratio of ten percent. Given this information, we can say First National Bank has ________ million dollars in excess reserves.
A) two
B) eight
C) nine
D) ten
3) Suppose that from a new checkable deposit, First National Bank holds eight million dollars on deposit with the Federal Reserve, one million dollars in required reserves, and faces a required reserve ratio of ten percent. Given this information, we can say First National Bank has ________ million dollars in vault cash.
1) Suppose that from a new checkable deposit, First National Bank holds eight million dollars on deposit with the Federal Reserve, nine million dollars in excess reserves, and faces a required reserve ratio of ten percent. Given this information, we can say First National Bank has ________ million dollars in required reserves.
A) one
B) two
C) nine
D) ten
2) Suppose that from a new checkable deposit, First National Bank holds eight million dollars on deposit with the Federal Reserve, nine million dollars in excess reserves, and faces a required reserve ratio of ten percent. Given this information, we can say First National Bank has ________ million dollars in vault cash.
A) one
B) two
C) nine
D) ten
3) The interest rate the Fed charges banks borrowing from the Fed is the
A) federal funds rate.
B) Treasury bill rate.
C) discount rate.
D) prime rate.
4) When banks borrow money from the Federal Reserve, these funds are called
1) Purchases and sales of government securities by the Federal Reserve are called
A) discount loans.
B) federal fund transfers.
C) open market operations.
D) swap transactions.
2) When the Federal Reserve purchases a government bond from a bank, reserves in the banking system ________ and the monetary base ________, everything else held constant.
A) increase; increases
B) increase; decreases
C) decrease; increases
D) decrease; decreases
3) When the Federal Reserve sells a government bond to a bank, reserves in the banking system ________ and the monetary base ________, everything else held constant.
A) increase; increases
B) increase; decreases
C) decrease; increases
D) decrease; decreases
4) When a bank sells a government bond to the Federal Reserve, reserves in the banking system ________ and the monetary base ________, everything else held constant.
1) If a person selling bonds to the Fed cashes the Fed”s check, then reserves ________ and currency in circulation ________, everything else held constant.
A) remain unchanged; declines
B) remain unchanged; increases
C) decline; remains unchanged
D) increase; remains unchanged
2) The effect of an open market purchase on reserves differs depending on how the seller of the bonds keeps the proceeds. If the proceeds are kept in ________, the open market purchase has no effect on reserves; if the proceeds are kept as ________, reserves increase by the amount of the open market purchase.
A) deposits; deposits
B) deposits; currency
C) currency; deposits
D) currency; currency
3) The effect of an open market purchase on reserves differs depending on how the seller of the bonds keeps the proceeds. If the proceeds are kept in currency, the open market purchase ________ reserves; if the proceeds are kept as deposits, the open market purchase ________ reserves.
1) There are two ways in which the Fed can provide additional reserves to the banking system: it can ________ government bonds or it can ________ discount loans to commercial banks.
A) sell; extend
B) sell; call in
C) purchase; extend
D) purchase; call in
2) A decrease in ________ leads to an equal ________ in the monetary base in the short run.
A) float; increase
B) float; decrease
C) Treasury deposits at the Fed; decrease
D) discount loans; increase
3) The monetary base declines when
A) the Fed extends discount loans.
B) Treasury deposits at the Fed decrease.
C) float increases.
D) the Fed sells securities.
4) An increase in ________ leads to an equal ________ in the monetary base in the short run.
1) A decrease in ________ leads to an equal ________ in the monetary base in the long run.
A) float; increase
B) float; decrease
C) securities; increase
D) securities; decrease
2) An increase in ________ leads to an equal ________ in the monetary base in the long run.
A) float; increase
B) float; decrease
C) securities; increase
D) securities; decrease
3) Suppose a person cashes his payroll check and holds all the funds in the form of currency. Everything else held constant, total reserves in the banking system ________ and the monetary base ________.
A) remain unchanged; increases
B) decrease; increases
C) decrease; remains unchanged
D) decrease; decreases
4) Suppose your payroll check is directly deposited to your checking account. Everything else held constant, total reserves in the banking system ________ and the monetary base ________.
1) The Fed does not tightly control the monetary base because it does not completely control
A) open market purchases.
B) open market sales.
C) borrowed reserves.
D) the discount rate.
2) Subtracting borrowed reserves from the monetary base obtains
A) reserves.
B) high powered money.
C) the nonborrowed monetary base.
D) the borrowed monetary base.
3) The relationship between borrowed reserves, the nonborrowed monetary base, and the monetary base is
A) MB = MBn BR.
B) BR = MBn MB.
C) BR = MB MBn.
D) MB = BR MBn.
4) Explain two ways by which the Federal Reserve System can increase the monetary base. Why is the effect of Federal Reserve actions on bank reserves less exact than the effect on the monetary base?
1) In a ________ banking system, commercial banks provide a full range of banking, securities, and insurance services, all within a single legal entity.
A) universal
B) severable
C) barrier free
D) dividerless
2) In a ________ banking system, commercial banks engage in securities underwriting, but legal subsidiaries conduct the different activities. Also, banking and insurance are not typically undertaken together in this system.
A) universal
B) British style universal
C) short fence
D) compartmentalized
3) A major difference between the United States and Japanese banking systems is that
A) American banks are allowed to hold substantial equity stakes in commercial firms, whereas Japanese banks cannot.
B) Japanese banks are allowed to hold substantial equity stakes in commercial firms, whereas
American banks cannot.
C) bank holding companies are illegal in the United States.
D) Japanese banks are usually organized as bank holding companies.
Thrift Industry: Regulation and Structure
4) Like the dual banking system for commercial banks, thrifts can have either ________ or ________ charters.
1) A nominal variable, such as the inflation rate or the money supply, which ties down the price level to achieve price stability is called ________ anchor.
A) a nominal
B) a real
C) an operating
D) an intermediate
2) A central feature of monetary policy strategies in all countries is the use of a nominal variable that monetary policymakers use as an intermediate target to achieve an ultimate goal such as price stability. Such a variable is called a nominal
A) anchor.
B) benchmark.
C) tether.
D) guideline.
3) A central feature of monetary policy strategies in all countries is the use of a nominal anchor, which is a nominal variable that monetary policymakers use as an
A) operating target, such as the federal funds interest rate.
B) intermediate target, such as the federal funds interest rate.
C) intermediate target to achieve an ultimate goal such as price stability.
D) operating target to achieve an ultimate goal such as exchange rate stability.
1) Monetary policy is considered time inconsistent because
A) of the lag times associated with the implementation of monetary policy and its effect on the economy.
B) policymakers are tempted to pursue discretionary policy that is more contractionary in the short run.
C) policymakers are tempted to pursue discretionary policy that is more expansionary in the short run.
D) of the lag times associated with the recognition of a potential economic problem and the implementation of monetary policy.
2) The time inconsistency problem with monetary policy tells us that, if policymakers use discretionary policy, there is a higher probability that the ________ will be higher, compared to policy makers following a behavior rule.
1) The time inconsistency problem in monetary policy can occur when the central bank conducts policy
A) using a nominal anchor.
B) using a strict and inflexible rule.
C) on a discretionary, day by day basis.
D) using a flexible, discretionary rule.
2) Explain the time inconsistency problem. What is the likely outcome of discretionary policy? What are the solutions to the time inconsistency problem?
Other Goals of Monetary Policy
3) Even if the Fed could completely control the money supply, monetary policy would have critics because
A) the Fed is asked to achieve many goals, some of which are incompatible with others.
B) the Fed”s goals do not include high employment, making labor unions a critic of the Fed.
C) the Fed”s primary goal is exchange rate stability, causing it to ignore domestic economic conditions.
D) it is required to keep Treasury security prices high.
A) raise interest rates through contractionary monetary policy.
B) increase federal government expenditures.
C) increase consumption expenditures by increasing taxes.
D) increase saving and investment using tax incentives.
2) The Federal Reserve System was created to
A) make it easier to finance budget deficits.
B) promote financial market stability.
C) lower the unemployment rate.
D) promote rapid economic growth.
3) Having interest rate stability
A) allows for less uncertainty about future planning.
B) leads to demands to curtail the Fed”s power.
C) guarantees full employment.
D) leads to problems in financial markets.
4) Foreign exchange rate stability is important because a decline in the value of the domestic currency will ________ the inflation rate, and an increase in the value of the domestic currency makes domestic industries ________ competitive with competing foreign industries.
1) Which of the following is NOT an entity of the Federal Reserve System?
A) Federal Reserve Banks
B) The Comptroller of the Currency
C) The Board of Governors
D) The Federal Open Market Committee
2) Which of the following is an entity of the Federal Reserve System?
A) The U.S. Treasury Secretary
B) The FOMC
C) The Comptroller of the Currency
D) The FDIC
3) The three largest Federal Reserve banks (New York, Chicago, and San Francisco) combined hold more than ________ percent of the assets of the Federal Reserve System.
A) 25
B) 33
C) 50
D) 67
4) The Federal Reserve Banks are ________ institutions since they are owned by the ________.
A) quasi public; private commercial banks in the district where the Reserve Bank is located
B) public; private commercial banks in the district where the Reserve Bank is located
1) Each Federal Reserve bank has nine directors. Of these ________ are appointed by the member banks and ________ are appointed by the Board of Governors.
A) three; six
B) four; five
C) five; four
D) six; three
2) The nine directors of the Federal Reserve Banks are split into three categories: ________ are professional bankers, ________ are leaders from industry, and ________ are to represent thepublic interest and are not allowed to be officers, employees, or stockholders of banks.
A) 5; 2; 2
B) 2; 5; 2
C) 4; 2; 3
D) 3; 3; 3
3) Member commercial banks have purchased stock in their district Fed banks; the dividend paid by that stock is limited by law to ________ percent annually.
A) four
B) five
C) six
D) eight
4) The Federal Reserve Bank of ________ plays a special role in the Federal Reserve System because it houses the open market desk.
1) The majority of members of the Federal Open Market Committee are
A) Federal Reserve Bank presidents.
B) members of the Federal Advisory Council.
C) presidents of member banks.
D) the seven Federal Reserve governors.
2) Each Fed bank president attends FOMC meetings; although only ________ Fed bank presidents vote on policy, all ________ provide input.
A) three; ten
B) five; ten
C) three; twelve
D) five; twelve
3) Although neither ________ nor the ________ are officially set by the Federal Open Market Committee, decisions concerning these policy tools are effectively made by the committee.
A) margin requirements; discount rate
B) margin requirements; federal funds rate
C) reserve requirements; discount rate
D) reserve requirements; federal funds rate
4) The research document given to the Federal Open Market Committee that contains information on the state of the economy in each Federal Reserve district is called the
1) The research document given to the Federal Open Market Committee that contains the forecast of national economic variables for the next two years is called the
A) beige book.
B) green book.
C) blue book.
D) black book.
2) The research document given to the Federal Open Market Committee that contains forecasts of the money aggregates conditional on different monetary policy stances is called the
A) beige book.
B) green book.
C) blue book.
D) black book.
3) The Federal Open Market Committee”s “balance of risks” is an assessment of whether, in the future, its primary concern will be
Takeover Target is run by entrenched management that insists on reinvesting 60% of its earnings in projects that provide an ROE of 10%, despite the fact that the firm’s capitalization rate is k = 15%. The firm’s year end dividend will be $2 per share, paid out of earnings of $5 per share. At what price will the stock sell? What is the present value of growth opportunities? Why would such a firm be a takeover target for another firm? Given current management’s investment policy, the dividend growth rate will be
g = ROE x b =10% x0.6 = 6% and the stock price should be P0 = $2/0.15 0.06 =$22.22 The present value of growth opportunities is PVGO = Price per share No growth value per share = $22.22 E1/k =$22.22 $5/0.15= $11.11 PVGO is negative. This is because the net present value of the firm’s projects is negative: The rate of return on those assets is less than the opportunity cost of capital. Such a firm would be subject to takeover, because another firm could buy the firm for the market price of $22.22 per share and increase the value of the firm by changing its investment policy. For example, if the new management simply paid out all earnings as dividends, the value of the firm would increase to its no growth value, E1/k =$5/0.15 = $33.33.
The following cash receipts journal headings have been suggested for a small service firm. List the errors you find in the headings.
CASH RECEIPTS JOURNAL
Fees
Accts.
Other
Account
Post.
Earned
Rec.
Cash
Accounts
Date
Credited
Ref.
Cr.
Cr.
Cr.
Dr.
Lee Technical Services Inc. was established on June 15, 2008. The clients for whom Lee provided technical services during the remainder of June are listed below. These clients pay Lee the amount indicated plus a 5% sales tax.
June 16. Issued Invoice No. 1 to A. Sommerfeld for $400 plus tax on account.
June 19. Issued Invoice No. 2 to R. Mendoza for $180 plus tax.
June 21. Issued Invoice No. 3 to J. Koss for $100 plus tax.
June 22. Issued Invoice No. 4 to D. Jeffries for $160 plus tax.
June 24. Provided services to K. Sallinger, in exchange for office supplies having a value of $100, plus tax.
June 26. Issued Invoice No. 5 to J. Koss for $280 plus tax.
June 28. Issued Invoice No. 6 to R. Mendoza for $40 plus tax.
a. Journalize the transactions for June, using a three column revenue journal and a two column general journal. Post the customer accounts in the accounts receivable subsidiary ledger, and insert the balance immediately after recording each entry.
b. Post the general journal and the revenue journal to the following general ledger accounts, inserting account balances only after the last postings:
12
Accounts Receivable
14
Office Supplies
22
Sales Tax Payable
41
Fees Earned
c. 1. What is the sum of the balances in the accounts receivable subsidiary ledger at June 30?
2. What is the balance of the controlling account at June 30?
A Plus Learning Centers was established on March 20, 2008, to provide educational services. The services provided during the remainder of the month are as follows:
Mar. 21. Issued Invoice No. 1 to J. Dunlop for $70 on account.
Mar. 22. Issued Invoice No. 2 to K. Thorne for $310 on account.
Mar.24. Issued Invoice No. 3 to T. Morris for $95 on account.
Mar.25. Provided educational services, $125, to K. Thorne in exchange for educational supplies.
Mar.27. Issued Invoice No. 4 to F. Mintz for $190 on account.
Mar.28. Issued Invoice No. 5 to D. Bennett for $175 on account.
Mar.30. Issued Invoice No. 6 to K. Thorne for $105 on account.
Mar.31. Issued Invoice No. 7 to T. Morris for $115 on account.
Instructions
1. Journalize the transactions for March, using a single column revenue journal and a two column general journal. Post to the following customer accounts in the accounts receivable ledger, and insert the balance immediately after recording each entry: D. Bennett; J. Dunlop; F. Mintz; T. Morris; K. Thorne.
2. Post the revenue journal and the general journal to the following accounts in the general ledger, inserting the account balances only after the last postings:
12
Accounts Receivable
13
Supplies
41
Fees Earned
3. a. What is the sum of the balances of the accounts in the subsidiary ledger at March 31?
b. What is the balance of the controlling account at March 31?
4. Assume that on April 1, the state in which A Plus operates begins requiring that sales tax be collected on educational services. Briefly explain how the revenue journal may be modified to accommodate sales of services on account that require the collection of a state sales tax.
Transactions related to revenue and cash receipts completed by Palm Beech Architects Co. during the period September 2–30, 2008, are as follows:
Sept
2
Issued Invoice No. 793 to Morton Co., $5,400.
5
Received cash from Mendez Co. for the balance owed on its account.
6
Issued Invoice No. 794 to Quest Co., $1,980.
13
Issued Invoice No. 795 to Shilo Co., $2,950.
Post revenue and collections to the accounts receivable subsidiary ledger.
15
Received cash from Quest Co. for the balance owed on September 1.
16
Issued Invoice No. 796 to Quest Co., $6,100.
Post revenue and collections to the accounts receivable subsidiary ledger.
19
Received cash from Morton Co. for the balance due on invoice of September 2.
20
Received cash from Quest Co. for invoice of September 6.
22
Issued Invoice No. 797 to Mendez Co., $8,020.
25
Received $2,000 note receivable in partial settlement of the balance due on the
Shilo Co. account.
30
Recorded cash fees earned, $11,930.
Post revenue and collections to the accounts receivable subsidiary ledger.
Instructions
1. Insert the following balances in the general ledger as of September 1:
11
Cash
$13,650
12
Accounts Receivable
15,370
14
Notes Receivable
5,000
41
Fees Earned
—
2. Insert the following balances in the accounts receivable subsidiary ledger as of September 1:
Mendez Co.
$8,960
Morton Co.
—
Quest Co.
6,410
Shilo Co.
—
3. Prepare a single column revenue journal and a cash receipts journal. Use the following column headings for the cash receipts journal: Fees Earned, Accounts Receivable, and Cash. The Fees Earned column is used to record cash fees. Insert a check mark (??) in the Post. Ref. column.
4. Using the two special journals and the two column general journal, journalize the transactions for September. Post to the accounts receivable subsidiary ledger, and insert the balances at the points indicated in the narrative of transactions. Determine the balance in the customer’s account before recording a cash receipt.
5. Total each of the columns of the special journals, and post the individual entries and totals to the general ledger. Insert account balances after the last posting.
6. Determine that the subsidiary ledger agrees with the controlling account in the general ledger.
Forever Spring Landscaping designs and installs landscaping. The landscape designers and office staff use office supplies, while field supplies (rock, bark, etc.) are used in the actual landscaping. Purchases on account completed by Forever Spring Landscaping during May 2008 are as follows:
May
2
Purchased office supplies on account from Lawson Co., $360.
5
Purchased office equipment on account from Peach Computers Co., $5,150.
9
Purchased office supplies on account from Executive Office Supply Co., $305.
13
Purchased field supplies on account from Yee Co., $1,360.
14
Purchased field supplies on account from Nelson Co., $2,940.
17
Purchased field supplies on account from Yee Co., $1,345.
24
Purchased field supplies on account from Nelson Co., $3,810.
29
Purchased office supplies on account from Executive Office Supply Co., $225.
31
Purchased field supplies on account from Nelson Co., $1,005.
Instructions
1. Insert the following balances in the general ledger as of May 1:
14
Field Supplies
$ 6,310
15
Office Supplies
830
18
Office Equipment
14,300
21
Accounts Payable
1,105
2. Insert the following balances in the accounts payable subsidiary ledger as of May 1:
Executive Office Supply
$365
Lawson Co.
740
Nelson Co.
—
Peach Computers Co.
—
Yee Co.
—
3. Journalize the transactions for May, using a purchases journal similar to the one illustrated in this chapter. Prepare the purchases journal with columns for Accounts Payable, Field Supplies, Office Supplies, and Other Accounts. Post to the creditor accounts in the accounts payable subsidiary ledger immediately after each entry.
4. Post the purchases journal to the accounts in the general ledger.
5. a. What is the sum of the balances in the subsidiary ledger at May 31?
b. What is the balance of the controlling account at May 31?
Artesian Springs Water Testing Service was established on September 16, 2008. Artesian uses field equipment and field supplies (chemicals and other supplies) to analyze water for unsafe contaminants in streams, lakes, and ponds. Transactions related to purchases and cash payments during the remainder of September are as follows:
Sept.
16
Issued Check No. 1 in payment of rent for the remainder of September, $1,500.
16
Purchased field supplies on account from Heath Supply Co., $4,360.
16
Purchased field equipment on account from Test Rite Equipment Co., $15,900.
17
Purchased office supplies on account from Baker Supply Co., $280.
19
Issued Check No. 2 in payment of field supplies, $2,420, and office supplies, $300.
Post the journals to the accounts payable subsidiary ledger.
23
Purchased office supplies on account from Baker Supply Co., $410.
23
Issued Check No. 3 to purchase land, $35,000.
24
Issued Check No. 4 to Heath Supply Co. in payment of invoice, $4,360.
26
Issued Check No. 5 to Test Rite Equipment Co. in payment of invoice, $15,900.
Post the journals to the accounts payable subsidiary ledger.
30
Acquired land in exchange for field equipment having a cost of $7,000.
30
Purchased field supplies on account from Heath Supply Co., $5,300.
30
Issued Check No. 6 to Baker Supply Co. in payment of invoice, $280.
30
Purchased the following from Test Rite Equipment Co. on account: field supplies,
$700, and field equipment, $3,600.
30
Issued Check No. 7 in payment of salaries, $21,400.
Post the journals to the accounts payable subsidiary ledger.
Instructions
1. Journalize the transactions for September. Use a purchases journal and a cash payments journal, similar to those illustrated in this chapter, and a two column general journal. Use debit columns for Field Supplies, Office Supplies, and Other Accounts in the purchases journal. Refer to the following partial chart of accounts:
11
Cash
19
Land
14
Field Supplies
21
Accounts Payable
15
Office Supplies
61
Salary Expense
17
Field Equipment
71
Rent Expense
At the points indicated in the narrative of transactions, post to the following accounts in the accounts payable subsidiary ledger:
Baker Supply Co.
Heath Supply Co.
Test Rite Equipment Co.
2. Post the individual entries (Other Accounts columns of the purchases journal and the cash payments journal and both columns of the general journal) to the appropriate general ledger accounts.
3. Total each of the columns of the purchases journal and the cash payments journal, and post the appropriate totals to the general ledger. (Because the problem does not include transactions related to cash receipts, the cash account in the ledger will have a credit balance.)
Washington Surveyors provides survey work for construction projects. The office staff use office supplies, while surveying crews use field supplies. Purchases on account completed by Washington Surveyors during October 2008 are as follows:
Oct.
1
Purchased field supplies on account from Wendell Co., $2,540.
3
Purchased office supplies on account from Lassiter Co., $280.
8
Purchased field supplies on account from Precision Supplies, $3,640.
12
Purchased field supplies on account from Wendell Co., $3,000.
15
Purchased office supplies on account from J Mart Co., $390.
19
Purchased office equipment on account from Eskew Co., $7,000.
23
Purchased field supplies on account from Precision Supplies, $1,940.
26
Purchased office supplies on account from J Mart Co., $185.
30
Purchased field supplies on account from Precision Supplies, $2,650.
Instructions
1. Insert the following balances in the general ledger as of October 1:
14
Field Supplies
$ 5,300
15
Office Supplies
1,230
18
Office Equipment
18,400
21
Accounts Payable
4,540
2. Insert the following balances in the accounts payable subsidiary ledger as of October 1:
Eskew Co.
$3,500
J Mart Co.
620
Lassiter Co.
420
Precision Supplies
—
Wendell Co.
—
3. Journalize the transactions for October, using a purchases journal similar to the one illustrated in this chapter. Prepare the purchases journal with columns for Accounts Payable, Field Supplies, Office Supplies, and Other Accounts. Post to the creditor accounts in the accounts payable ledger immediately after each entry.
4. Post the purchases journal to the accounts in the general ledger.
5. a. What is the sum of the balances in the subsidiary ledger at October 31?
b. What is the balance of the controlling account at October 31?
Texas Tea Exploration Co. was established on March 15, 2008, to provide oil drilling services. Texas Tea uses field equipment (rigs and pipe) and field supplies (drill bits and lubricants) in its operations. Transactions related to purchases and cash payments during the remainder of March are as follows:
Mar.
16
Issued Check No. 1 in payment of rent for the remainder of March, $4,800.
16
Purchased field equipment on account from PMI Sales Inc., $28,500.
17
Purchased field supplies on account from Culver Supply Co., $8,740.
18
Issued Check No. 2 in payment of field supplies, $2,150, and office supplies, $390.
20
Purchased office supplies on account from Castle Office Supply Co., $1,060.
24
Issued Check No. 3 to PMI Sales Inc., in payment of March 16 invoice.
26
Issued Check No. 4 to Culver Supply Co. in payment of March 17 invoice.
28
Issued Check No. 5 to purchase land, $165,000.
28
Purchased office supplies on account from Castle Office Supply Co., $2,570.
30
Purchased the following from PMI Sales Inc. on account: field supplies, $21,380,
and office equipment, $12,200.
30
Issued Check No. 6 to Castle Office Supply Co. in payment of March 20 invoice.
30
Purchased field supplies on account from Culver Supply Co., $11,100.
31
Issued Check No. 7 in payment of salaries, $24,500.
31
Rented building for one year in exchange for field equipment having a cost of
$12,400.
Instructions
1. Journalize the transactions for March. Use a purchases journal and a cash payments journal, similar to those illustrated in this chapter, and a two column general journal. Set debit columns for Field Supplies, Office Supplies, and Other Accounts in the purchases journal. Refer to the following partial chart of accounts:
11
Cash
18
Office Equipment
14
Field Supplies
19
Land
15
Office Supplies
21
Accounts Payable
16
Prepaid Rent
61
Salary Expense
17
Field Equipment
71
Rent Expense
At the points indicated in the narrative of transactions, post to the following accounts in the accounts payable ledger:
Castle Office Supply Co.
Culver Supply Co.
PMI Sales Inc.
2. Post the individual entries (Other Accounts columns of the purchases journal and the cash payments journal; both columns of the general journal) to the appropriate general ledger accounts.
3. Total each of the columns of the purchases journal and the cash payments journal, and post the appropriate totals to the general ledger. (Because the problem does not include transactions related to cash receipts, the cash account in the ledger will have a credit balance.)
The transactions completed by One Day Courier Company during May 2008, the first month of the fiscal year, were as follows:
May
1
Issued Check No. 205 for May rent, $800.
2
Purchased a vehicle on account from McIntyre Sales Co., $21,700.
3
Purchased office equipment on account from Office Mate Inc., $470.
5
Issued Invoice No. 91 to Martin Co., $4,700.
6
Received check for $5,240 from Baker Co. in payment of invoice.
7
Issued Invoice No. 92 to Trent Co., $7,900.
9
Issued Check No. 206 for fuel expense, $590.
10
Received check for $7,490 from Sing Co. in payment of invoice.
10
Issued Check No. 207 to Office City in payment of $440 invoice.
10
Issued Check No. 208 to Bastille Co. in payment of $1,250 invoice.
11
Issued Invoice No. 93 to Jarvis Co., $6,300.
11
Issued Check No. 209 to Porter Co. in payment of $290 invoice.
12
Received check for $4,700 from Martin Co. in payment of invoice.
13
Issued Check No. 210 to McIntyre Sales Co. in payment of $21,700 invoice.
16
Cash fees earned for May 1–16, $16,800.
16
Issued Check No. 211 for purchase of a vehicle, $21,800.
17
Issued Check No. 212 for miscellaneous administrative expense, $3,700.
18
Purchased maintenance supplies on account from Bastille Co., $1,590.
18
Received check for rent revenue on office space, $1,000.
19
Purchased the following on account from Master Supply Co.: maintenance supplies,
$1,950, and office supplies, $1,550.
20
Issued Check No. 213 in payment of advertising expense, $6,900.
20
Used maintenance supplies with a cost of $2,200 to repair vehicles.
21
Purchased office supplies on account from Office City, $630.
24
Issued Invoice No. 94 to Sing Co., $7,590.
25
Received check for $11,700 from Baker Co. in payment of invoice.
25
Issued Invoice No. 95 to Trent Co., $4,870.
26
Issued Check No. 214 to Office Mate Inc. in payment of $470 invoice.
27
Issued Check No. 215 to F. Desai as a personal withdrawal, $3,000.
30
Issued Check No. 216 in payment of driver salaries, $26,900.
31
Issued Check No. 217 in payment of office salaries, $16,800.
31
Issued Check No. 218 for office supplies, $300.
31
Cash fees earned for May 17–31, $18,500.
Instructions
Enter the following account balances in the general ledger as of May 1:
11
Cash
$ 57,900
18
Vehicles
$ 48,000
12
Accounts Receivable
24,430
19
Accumulated Depreciation
14
Maintenance Supplies
6,150
—Vehicles
13,590
15
Office Supplies
2,580
21
Accounts Payable
1,980
16
Office Equipment
14,370
31
F. Desai, Capital
135,280
17
Accumulated Depreciation
32
F. Desai, Drawing
—
—Office Equipment
2,580
41
Fees Earned
—
42
Rent Revenue
—
61
Office Salaries Expense
—
51
Driver Salaries Expense
—
62
Rent Expense
—
52
Maintenance Supplies
63
Advertising Expense
—
Expense
—
64
Miscellaneous Adminis-
53
Fuel Expense
—
trative Expense
—
2. Journalize the transactions for May 2008, using the following journals similar to those illustrated in this chapter: single-column revenue journal, cash receipts journal, purchases journal (with columns for Accounts Payable, Maintenance Supplies, Office Supplies, and Other Accounts), cash payments journal, and two-column general journal. Assume that the daily postings to the individual accounts in the accounts payable ledger and the accounts receivable ledger have been made.
3. Post the appropriate individual entries to the general ledger.
4. Total each of the columns of the special journals, and post the appropriate totals to the general ledger; insert the account balances.
5. Prepare a trial balance.
6. Verify the agreement of each subsidiary ledger with its controlling account. The sum of the balances of the accounts in the subsidiary ledgers as of May 31 are as follows:
Sharon Els sells security systems for Guardsman Security Co. Els has a monthly sales quota of $40,000. If Els exceeds this quota, she is awarded a bonus. In measuring the quota, a sale is credited to the salesperson when a customer signs a contract for installation of a security system. Through the 25th of the current month, Els has sold $30,000 in security systems.
Vortex Co., a business rumored to be on the verge of bankruptcy, contacted Els on the 26th of the month about having a security system installed. Els estimates that the contract would yield about $14,000 worth of business for Guardsman Security Co. In addition, this contract would be large enough to put Els “over the top” for a bonus in the current month. However, Els is concerned that Vortex Co. will not be able to make the contract payment after the security system is installed. In fact, Els has heard rumors that a competing security services company refused to install a system for Vortex Co. because of these concerns. Upon further consideration, Els concluded that her job is to sell security systems and that it’s someone else’s problem to collect the resulting accounts receivable. Thus, Els wrote the contract with Vortex Co. and received a bonus for the month.
a. Discuss whether Sharon Els was acting in an ethical manner.
b. How might Guardsman Security Co. prevent this scenario from occurring?
Cisco Systems, Inc., pioneered the concept of a “virtual close” of the financial records. A virtual close is described as follows:
The traditional practice of closing a company’s books on a monthly, quarterly, or annual basis is out of sync with the dynamics of the new economy. In the past, the financial close and subsequent report generation was a static, scheduled event. It consumed days, weeks, and months and was based on a “thick black book.” The new paradigm is driven by dynamic information accessible anytime and anywhere. Web based reporting tools allow for real time access to the very latest data and make interaction, summary to detail drill downs, and various data views possible. The result is fast, intuitive, on the fly creation of information views targeted for a specific analytical need to answer a specific question.
Additional information about the virtual close can be found at Cisco’s Web site, which is linked to the text’s Web site at www.thomsonedu.com/accounting/warren.
a. How is a virtual close different from traditional practice?
b. How does the virtual close impact the decision making ability of Cisco’s management.
1) Newly issued high yield bonds rated below investment grade by the bond rating agencies are frequently referred to as
A) municipal bonds.
B) Yankee bonds.
C) “fallen angels.”
D) junk bonds.
2) In 1977, he pioneered the concept of selling new public issues of junk bonds for companies that had not yet achieved investment grade status.
A) Michael Milken
B) Roger Milliken
C) Ivan Boskey
D) Carl Ichan
3) One factor contributing to the rapid growth of the commercial paper market since 1970 is
A) the fact that commercial paper has no default risk.
B) improved information technology making it easier to screen credit risks.
C) government regulation.
D) FDIC insurance for commercial paper.
4) The development of money market mutual funds contributed to the growth of ________ since the money market mutual funds need to hold liquid, high quality, short terms assets.
1) In September 2008, the Reserve Primary Fund, a money market mutual fund, found itself in the situation know as “breaking the buck.” This means that
A) they could no longer afford to redeem shares at the par value of $1.
B) they required shareholders to contribute a dollar more in fees each month.
C) shareholders were able to redeem shares for more than a $1.
D) shares earned more than a dollar in interest.
2) In this type of arrangement, any balances above a certain amount in a corporation”s checking account at the end of the business day are “removed” and invested in overnight securities that pay the corporation interest. This innovation is referred to as a
A) sweep account.
B) share draft account.
C) removed repo account.
D) stockman account.
3) Sweep accounts which were created to avoid reserve requirements became possible because of a change in ________.
A) demand conditions
B) supply conditions
C) government rules
D) bank mergers
4) Sweep accounts
A) have made reserve requirements nonbonding for many banks.
B) sweep funds out of deposit accounts into long term securities.
C) enable banks to avoid paying interest to corporate customers.
A) effectively prohibited banks from branching across state lines.
B) required that banks maintain bank capital equal to at least 6 percent of their assets.
C) effectively required that banks maintain a correspondent relationship with large money center banks.
D) separated the commercial banks and investment banks.
2) The legislation that effectively prohibited banks from branching across state lines and forced all national banks to conform to the branching regulations in the state in which they reside is the
A) McFadden Act.
B) National Bank Act.
C) Glass Steagall Act.
D) Garn St.Germain Act.
3) The large number of banks in the United States is an indication of
A) vigorous competition within the banking industry.
B) lack of competition within the banking industry.
C) only efficient banks operating within the United States.
D) consumer preference for local banks.
4) Lack of competition in the United States banking industry can be attributed to
A) the fact that competition does not benefit consumers.
B) the fact that branching has eliminated competition.
Accept special sales order? Circuit Masters, Inc. (CMI), is presently operating at 80% of capacity and manufacturing 120,000 units of a patented electronic component. The cost structure of the component is as follows:
Raw materials
$ 6.00 per unit
Direct labor
6.00 per unit
Variable overhead
8.00 per unit
Fixed overhead
$480,000 per year
An Italian firm has offered to purchase 20,000 of the components at a price of $24 per unit, FOB CMI’s plant. The normal selling price is $32 per component. This special order will not affect any of CMI’s “normal” business. Management calculated that the cost per component is $24, so it is reluctant to accept this special order.
Required:
a. Show how management came up with a cost of $24 per unit for this component.
b. Evaluate this cost calculation. Explain why it is or is not appropriate.
c. Should the offer from the Italian firm be accepted? Why or why not?
Accept special sales order? AAA Lock Manufacturing Co. makes and sells several models of locks. The cost records for the ZForce lock show that manufacturing costs total $29.00 per lock. An analysis of this amount indicates that $16.75 of the total cost has a variable cost behavior pattern, and the remainder is an allocation of fixed manufacturing overhead. The normal selling price of this model is $38.75 per lock. A chain store has offered to buy 15,000 ZForce locks from AAA Lock at a price of $20.00 each to sell in a market that would not compete with AAA Lock’s regular business. AAA Lock has manufacturing capacity available and could make these locks without incurring additional fixed manufacturing overhead.
Required:
a. Calculate the effect on AAA Lock’s operating income of accepting the order from the chain store.
b. If AAA Lock’s costs had not been classified by cost behavior pattern, is it likely that a correct special order analysis would have been made? Explain your answer.
c. Identify the key qualitative factors that AAA Lock managers should consider with respect to this special order decision.
Target costing Canton Company, a manufacturer of digital cameras, is considering entry into the digital binocular market. Canton Company currently does not produce binoculars of any style, so this venture would require a careful analysis of relevant manufacturing costs to correctly assess its ability to compete. The market price for this binocular style is well established at $49 per unit. Canton has enough square footage in its plant to accommodate the new production line, although several pieces of new equipment would be required; their estimated cost is $2,500,000. Canton requires a minimum ROI of 10% on any product line investment and estimates that if it enters this market with its digital binocular product at the prevailing market price, it is confident of its ability to sell 20,000 units each year.
Required:
a. Describe, in general terms, any costs that Canton Company would consider relevant to the decision of entering the digital binocular market.
b. Calculate the target cost per unit for entry into the digital binocular market.
Target costing Rainbow Cruises operates a week long cruise tour through the Hawaiian Islands. Passengers currently pay $1,800 for a two person cabin, which is an all inclusive price that includes food, beverages, and entertainment. The current cost to Rainbow per two person cabin is $1,440 for the week long cruise, and at this cost, Rainbow is able to earn the minimum profit margin needed to operate the business.
Rainbow competes with two other cruise lines and, to date, $1,800 has been the prevailing market price for the week long cruises. Each cruise line provides exactly the same services to their passengers, but recently one of Rainbow’s competitors found a way to permanently lower its price to $1,500 per two person cabin.
Required:
a. At a new market price of $1,500 per two person cabin, calculate the target cost that will allow Rainbow to earn the same profit margin percentage it currently earns.
b. Calculate the target cost reduction that Rainbow must achieve if it expects to remain competitive.
c. Describe several cost reduction initiatives that Rainbow might explore to achieve its target cost reduction requirements.
The make or buy decision Sycamore Company uses a certain part in its manufacturing process that it buys from an outside supplier for $29 per part plus another $4 for shipping and other purchasing related costs. The company will need 14,400 of these parts in the next year and is considering making the part internally.
After performing a capacity analysis, Sycamore determined that it has sufficient unused capacity to manufacture the 14,400 parts but would need to hire a manager at an annual salary of $43,200 to oversee this production activity. Estimated production costs are determined to be:
Direct material
$18
Direct labor
8
Variable overhead
4
Fixed overhead (includes manager at $3 per unit)
7
Total unit cost
$37
Required:
a. Identify the relevant costs to make this part internally.
b. Should Sycamore produce the part or continue to buy it from the outside supplier?
c. What other factors are important to this decision?
The product mix decision ABC Company produces Product X, Product Y, and Product Z. All three products require processing on specialized finishing machines.
The capacity of these machines is 3,600 hours per month. ABC Company wishes to determine the product mix that should be achieved to meet the high demand for each product and provide the maximum profit. Following is information about each product:
Product X
Product Y
Product Z
Selling price
$300
$240
$76
Variable costs
210
120
60
Machine time per unit
6 hours
4 hours
2 hours
Monthly demand (units)
360
240
600
Required:
Determine how the 3,600 hours of machine time should be allocated to the three products to provide the most profitable product mix.
Review problem—time value of money applications Use the appropriate factors from Table 6 4 or Table 6 5 to answer the following questions.
Required:
a. Staley Co.’s common stock is expected to have a dividend of $6 per share for each of the next 12 years, and it is estimated that the market value per share will be $136 at the end of 12 years. If an investor requires a return on investment of 12%, what is the maximum price the investor would be willing to pay for a share of Staley Co. common stock today?
b. Chapman bought a bond with a face amount of $1,000, a stated interest rate of 6%, and a maturity date 10 years in the future for $964. The bond pays interest on an annual basis. Five years have gone by and the market interest rate is now 8%. What is the market value of the bond today?
c. Laura purchased a U.S. Series EE savings bond for $100, and 10 years later received $259.40 when the bond was redeemed. What average annual return on investment did Laura earn over the 10 years?
Interpretation of present value analysis—calculate annual cash flow Lake Regional Hospital is considering the acquisition of a new diagnostic scanning machine. The investment required to get the machine operational will be $2,082,560.
The machine will be capable of performing 6,000 scanning procedures per year, but based on the experience of other hospitals, management estimates that the machine will be used at 80% of its capacity. The hospital’s cost of capital is 8%; the machine has an estimated useful life of seven years and no salvage value.
Required:
a. Assuming a constant cash flow every year, calculate the annual net cash flow required from the scanner if the IRR of the investment is to equal 8%.
b. If the direct cash costs of operating the scanner equal 50% of the annual net cash flow requirement calculated in part a, what price should the hospital charge per scanning procedure in order to achieve an 8% ROI?
Ethical Issue….docx
Exam for merc….pdf
project.xlsx