Financial analysis tests and assignments

TEST No.1

The Balance Sheet

1. If accounts payable=$14,000, Accrued liabilities =$4,137, Income taxes payable = $1,532 Short-term
debt =1,884 and Current Maturities of Long-Term Debt = $1,880 find total current liabilities.

2. If total current liabilities = $3,000 and deferred federal income taxes = 2,000$ and long-term debt =
$10,000 find the total liabilities.

3.What are Current Maturities of Long-Term Debt?

Answers:

1.Total current liabilities = 14,000 + 4,137 + 1,532 + 1,884 + 1,880 = $23,433

2.total liabilities = $15,000

3.When a firm has bonds, mortgages, or other forms of long-term debt outstanding, the portion of the
principal that will be repaid during the upcoming year is classified as a current liability.

4.define: accounts payable, short-term debt, accrued liabilities.

5.Assume that a company has a $100,000 note outstanding, with 12% annual interest due in semi-
annual installments on March 31 and September 30.For a balance sheet prepared on December 31,
interest will be accrued for 3 months. Present the situation of interests and accrued liabilities.

Answers:

4.Accounts payable = short-term obligations that arise from credit extended by suppliers for the
purchase of goods and services.

Short-term debt = consists of obligations in the form of promissory notes to suppliers or financial
institutions due in one year or less.

Accrued liabilities => from the recognition of an expense in the accounting records prior to the actual
payment of cash.

5.annual interest = $100,000 x 0.12= $12,000 annual interest

$12,000 / 12= $1,000 monthly interest, $1,000 x 3 = $3,000 accrued interest for three months.

Accruals also arise from salaries, rent, insurance, taxes and other expenses.

6. a)Why could be important the allowance for doubtful accounts?

b)What is allowance for doubtful accounts?

c)What is the operating cycle?

d)Give example of industries where operating cycle is longer.

e)(Net) working capital definition:

f)Give examples of cash equivalents;

g)What type of inventories you think would have a manufacturing firm?

h)Cost flow assumptions used by U.S. companies.

a)The allowance for doubtful accounts might can be important in assessing earnings quality.If, for
instance, a company expands sales by lowering its credit standards, there should be a corresponding
percentage increase in the allowance account.

b)Allowance for doubtful accounts is a contra-asset account that reduces the total receivables reported
to reflect only the accounts receivable expected to be collected. Is established by recognizing a bad debt
loss on the financial statements.

c)The operating cycle is the time required to purchase or manufacture inventory, sell the product and
collect the cash.

d)Tobacco and wine industry have longer operating cycles.

e)Working capital is used to designate the amount by which current assets exceed current liabilities.

f)Cash equivalents: money market funds, U.S.treasury bills, and commercial paper( unsecured short-
term corporate debt).

g)Raw materials or supplies, work-in-process, and finished goods.

For most firms, inventories are the firms major revenue producer.

h)LIFO,FIFO and Average Cost.

FIFO assumes the first units purchased are the first units sold during an accounting period, LIFO assumes
that the items bought last are sold first.

7.Match the following terms to the correct definitions:

a)Consolidated financial statements 1)Used up within 1Y or operating cycle,whichever is longer

b)Current assets 2)Expenses incurred prior to cash outflow

c)Depreciation 3)An agreement to use assets that is in substance a purchase

d)Deferred taxes 4)Estimation of uncollectible accounts receivable

e)Allowance for doubtful accounts 5)Cost allocation of fixed assets other than land

f)Prepaid expenses 6)Expenses paid in advance

g)Current maturities 7)Combined statements of parent company and subsidiaries

h)Accrued interest 8)Price at which stock trades

i)Capital lease 9)Difference in taxes reported and taxes paid

j)Market value of stock.10)Portion of debt to be repaid during the upcoming year.

a)-7) Consolidated financial statement = combined statements

b) -1)Current assets = Used up within one year or operating cycle, whichever is longer.

c)-5)Depreciation = Cost allocation of fixed assets other than land

d)-9)Deferred taxes = Difference in taxes reported and taxes paid.

e)-4)Allowance for doubtful accounts = Estimation of uncollectible accounts receivable.

f)-6,g)-10,h)-2,i)-3,j-8.

i)-3) Capital lease = An agreement to use assets that is in substance a purchase.

Part 2 Long lived assets

a)Tangible and intangible assets. Examples:

b)PPEs are current /non-current assets? Examples of intangible non-current assets.

c)What are capital expenditures? Examples related to PPE.

Answers:

a)Tangible non-current: PPE:property,plant,and equipment (long-lived assets).Intangible: copyright and

patents.

b)Non-current; .

c)Expenditures resulted in the acquisition of a non-current asset, including any additional costs involved
in preparing the asset for its intended use.

Examples:

Land:Costs to acquire PPE:purchase price,commission to real estate agent, legal fees.

The same for Building.

Equipment costs to acquire:Invoice cost,Transportation,Insurance(during transportation)

Related Question: What is invoice cost?An items invoice cost is the price a company pays to its
wholesale dealer to purchase the item for resale.

d)Factors necessary to compute depreciation.

Cost of the asset, residual value, estimated useful life or productive output.

Productive output = amount of goods and services expected to be provided.

e)Assume that Company X produces a $20,000 equipment on Jan 1,2015 with a residual value of 2,000$
and estimated productive life of 10,000 units.If 1,500 were produced during 2015 what is the
depreciation expense for 2015?

Solution:

(Cost residual value)/estimated output x Number of units produced = (20,000-2,000)/10,000 x

1,500=1.8 x 1,500 = 2,700 $(using the units of production method).

f) Based on the previous example what is the net book value of the asset?

Net Book Value = Cost Accumulated Depreciation = 20,000 2,700 = 17,300 $

g)If 2,000 units were produced in 2016, what would be the depreciation expense during that year?What
would be the carrying amount(net book value) at the end of 2016?

1.8 * 2000=3,600 $ (cost-residual value)/estimated output* number of units produced.

Net book value = 17,300 3,600 =13,700.

A PPE asset cannot be depreciated below its residual value.

Note: Residual value is the estimated worth of the asset at the end of its estimated useful life.

h)If the estimated useful life is 5 years, what is the depreciation expense?

(20,000-2,000)/5=3,600 $ / year.

Net book
value=NBV
Time
Depreciation
NBV start of NBV end of
Depreciation Year year year
Initial price $20,000 2015 $20,000 3,600 $16,400 Straight line
of
Residual val $2,000 2016 $16,400 3,600 $12,800 depreciation
Useful life 5 2017 $12,800 3,600 $9,200
Depreciation 3600 2018 $9,200 3,600 $5,600
expense 2019 $5,600 3,600 $2,000

REVISING DEPRECIATION

1.Initial price of the purchase is $20,000, initial estimation of residual value is $2,000 and useful life of 5
years .If the straight-line depreciation method is applied, and assuming that on January 1, management
assumes a new residual value $5,000 and 6 years what will be the annual depreciation expenses?

Solution:

After 2 years, Remaining carry amount = 20,000 (20,000 2,000)/5 *2 =20,000 7,200 = 12,800.
The depreciation expense for the remaining 6 years is (12,800 5,000)/6=1,300 $ /year.

SUBSEQUENT CAPITAL EXPENDITURES

1.Suppose the initial equipment value is on Jan 1,2015 20,000$, with residual value and useful life
2,000$ and 5 years respectively. Assume on Jan 5, 2016 a heat exchanger was added to the equipment
that allowed it to produce a new product in addition to the existing product line. This is worth $12,000
and useful life is 10 years and residual value 0$.

Solution:

To record revised straight-line depreciation :

(20,000-2,000)/5 years =3,600$/year; for the heat exchanger the depreciation annual expense is

(12,000 0)/10 =1,200$/year so we will account 4,800 $/year.

2.Suppose we had on Jan 1, 2015 equipment worth 20,000$ with a 5-year estimated life and 2,000$
residual value. Assume that on Jan 5,2018, the engine in the equipment burned out and needed to be
replaced. If the original cost was $8,000,useful life of 5 years,residual value of 1,000 $. What is the
accumulated depreciation?

Solution:

Accumulated depreciation = (8,000 -1,000)/5 =1,400$ yearly depreciation and hence 4,200 $
accumulated depreciation. The 3,800$ carrying amount represents a loss.

The entry to dispose of the old engine and remove it from the accounting records is:

General Journal

Date | Account / Explanation |Debit |Credit

Jan 5 |Accum.Dep. Equip. Engine . 4200

Loss on Disposal. 3800

Equipment - Engine 8000

IMPAIRMENT of LONG-LIVED ASSETS

Under GAAP, management must compare the recoverable amount of a long-lived asset with its
carrying amount (cost less accumulated depreciation) at the end of each reporting period.The
recoverable amount is the fair value of the asset at the time less any estimated costs to sell it. If the
recoverable amount is lower than the carrying amount, an impairment loss must be recorded.

Data: Initial cost = 20,000$, initial residual value estimated = 2,000$ (in Jan 2015).

In Jan 2017, the management remarks that the equipment is revaluated at 7,000$. Find the impairment
loss and the revised depreciation expense.
Solution:

At december 2016, the carrying amount value is 20,000 3,600 3,600 = 12,800. The recoverable value
is 7,000. The impairment loss is 12,800 - 7,000 = 5,800.

The revised depreciation expense is (7,000 - 2,000)/remaining years = 1,667 $(yearly).

DERECOGNITION OF Property,Plant & Equipment

1.When is PPE derecognized?

2.If the disposal occurs part way through the accounting period, depreciation must be updated.How?

3.Record the disposal including any resulting gain or loss by.

4.When is loss/gain resulting?

SALE or RETIREMENT of PPE

Describe the possible situations in case of selling PPE at the end of its useful life.

Answers:

1.PPE is derecognized when it is sold or when no future economic benefit is expected. To account for
the disposal of a PPE asset, the following must occur:

a)If the disposal occurs part way through the accounting period depreciation must be updated to the
date of disposal by

GENERAL Journal

Date | Account / Explanation |Debit |Credit

Depreciation expense xxxxx

Acc. Depreciation xxxxxx

To update depreciation for partial period

b) General Journal

Account/ explanation | Debit | Credit

Cash ..xxxxxxx

Acc. Depreciation xxxxxxx

Loss on Disposal ..xxxxxxx

Or gain on disposal xxxxxxx

PPE asset (such as equipment) xxxxxxxxx

To record disposal of PPE Asset

4.A loss results when the carrying amount of the asset is greater than the proceeds received, if any.
 A gain results when the carrying amount of the asset is less than any proceeds received.

The following types of sales might occur:

a.Sale at carrying amount

b.Sale above carrying amount

c.Sale below carrying amount

TEST NO.2

P1.1.Explain the process for determining whether the value of a long-lived asset has been impaired, and
the required adjustments to the accounting records.

2.Explain two types of partial-year depreciation methods.

3.WHEN Does the disposal of PPE not result in a gain or loss?

4.How is the cost of a new capital asset calculated when a trade-in is involved?

Answers:

1.At the end of each reporting period, the recoverable amount (fair value less estimated costs of
disposal) of an asset must be compared to its carrying value. If the recoverable amount is lower, the
carrying value must be adjusted downward (a credit to the asset account) and an impairment loss must
be recorded (a debit to an expense account) . Subsequent years depreciation expense calculations
must also be adjusted.

2.Partial-year depreciation can be calculated using the half-year rule or by pro-rating depreciation
expense over the number of months (rounded) that the asset was in use.

3.A gain or loss on disposal does not occur when the carrying amount of an asset is the same as the
proceeds of disposition.

4.The cost of the new asset is calculated as the sum of cash paid plus the fair value of the trade-in.

P2.a)Quick current assets vs. non-quick current assets;

b)

SAGE INC. CONSOLIDATED BALANCE SHEETS

Assets
Current Assets
Cash and cash equivalents $9,333
Accounts receivable,less allowance for doubtful accounts $8,960
Inventories $47,041
Prepaid expenses and other assets $512
Total current assets $65,846
PPE
Land $811
Buildings and leasehold improvements 18,273
Equipment 21,523
$40,607
Less accumulated depreciation and amortization 11,528
Net property,plant and equipment 29,079
Goodwill 270
Other Assets 103
Total Assets $95,298

Liabilities and Stockholder's equity

Current liabilities
Accounts payable $14,294
Accrued liabilities 4,137
Income taxes payable 1,532
Short-term debt 5,614
Current maturities of long-term debt 1,884
Total Current Liabilities $27,461
Deferred Federal Income Taxes 843
Long-term Debt 21,059
Commitments and Contingencies
Total liabilities $49,363
Stockholder's equity
Common stock,par value $0.01,authorized 10,000,000 shares;
issued 4,363,000 shares in 2016 and 4,355,000 shares in 2015;
and additional paid-in capital 5,760
Retained Earnings 40,175
Total stockholder's equity 45,935

Total Liabilities and Stockholder's Equity $95,298

INCOME STATEMENT

$215,60
Net sales 0
COGS 129,364
Gross Profit 86,236
Selling and advertisement exp. 45,722
Advertising 14,258
Depreciation and amortization 3,998
Impairment charges 3,015
 Operating profit 19,243
Other income(expense)
Interest income 422
Interest expense 2,585
EB income taxes 17,080
Provision for income taxes 7,686
Net earnings 9,394
Earnings per common share:
Basic $2.16
Diluted $2.12
Weighted average common share
Basic 4,359
Diluted 4,429

Compute the following ratios:

1.Quick Ratio; 2.Current Ratio;3.Debt to Equity Ratio; 4.Total asset turnover; 5.Accounts payable
turnover;

6.Gross profit margin; 7.Fixed asset turnover; 8.Operating profit margin;9.Net profit margin.

Answer:

1.Quick Ratio = (Current Assets Inventory )/(Current liabilities) = (65,846 47,041)/27,461=0.68 times

2.Current Ratio = Current Assets/Current Liabilities = 65,846/27,461 = 2.3978

3.Debt to Equity = Total Liabilities / Stockholders equity = 49,363/45,935 =1.07

4.Total asset turnover = Net sales / Total assets = 215,600/95,298 = 2.26 times

5.Accounts payable turnover = Cost of goods sold / Accounts payable = 129,364/14,294 = 9.05 times

6.Gross profit margin = Gross Profit/Net sales =86,236/215,600 = 40.0%.

7.Fixed asset turnover = Net Sales / Net PPE =215,600/29,079 = 7.41 times

8. Operating profit margin = Operating profit / Net sales = 19,243/215,600 = 8.9%

9.Net profit margin = Net earnings/ Net sales = 9,394/215,600 = 4.4%

All profitability ratios are referred to Net sales: See Gross Profit Margin, Operating Profit Margin, Net
Profit Margin

10.Return on Assets. 11.Return on Equity; 12.Net earnings/average shares outstaning;

10.Return on Assets = Net earnings / Total assets = 9,394/95,298 = 9.9%

11.Return on Equity = Net earnings / Stockholders equity = 9,394/45,395 = 20.5%

12.Net earnings / average shares outstanding = 9,394,000 / 4,359,041 = 2.16.