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12-6.

Cartwright Corporation Note to Instructor: For ease of discussion, the adjusting entries in the solution are dated to correspond with the original erroneous journal entries. In actual practice, they would be dated as of the year-end. Jan. 1 Organization Expenses Intangibles To classify incorporation fees. Organization Expenses Intangibles To classify legal fees for the organization of the company. Advertising Expense Intangibles To expense advertising costs. Land Building Intangibles To reclassify land and buildings for R & D activities. Research and Development Expenses Intangibles To expense materials purchased. * Alternatively, unused materials and supplies, if material, may be set up as prepaid expenses. Patent Intangibles To reclassify the patent. Income Summary / Retained Earnings Intangibles To record operating loss. Research and Development Expenses Intangibles To record acquisition of equipment. Research and Development Expenses Intangibles To expense R & D costs. Research and Development Expenses Accumulated Depreciation: Building To record year depreciation on R & D building (20year life) from April 1 entry. Amortization Expense Patent To record year amortization (20-year life) on June 30 patent. 17,500 17,500 7,500 7,500

10

15,000 15,000 15,000 20,000 35,000 15,000* 15,000

Apr. 1

May 15

June 30

10,000 10,000

July 1

12,000 12,000 12,000 12,000

Dec. 10

31

30,000 30,000

31

750 750

31

250 250

PAS 38 prohibits capitalization of start-up expenses such as organization costs. No amortization should therefore be recorded.

12-8.

Bayer, Inc. Net tangible assets per records, Nov. 1, 2006 Add: Agreed increase in value of equipment Net adjusted tangible assets Add: Value of Goodwill (Schedules 1 & 2) Total amount to be paid for net tangible assets and goodwill Supporting Computations: Schedule 1: Goodwill of Bayer, Inc. Average pre-tax earnings 11.1.01 to 11.1.06 Less: Additional annual depreciation equipment taken over at P40,000 in excess of book value (P40,000 / 5) Adjusted pre-tax earnings Less: Required earnings on net tangible assets (15% x P368,500) Excess annual pre-tax earnings Goodwill (excess earnings capitalized at 25%) Schedule 2: Goodwill of Lead, Inc. Average pre-tax earnings 11.1.01 to 11.1.06 Less: Adjustment for effect of organization cost written off in 2005 (P20,000 / 5) Adjusted pre-tax earnings Less: Required earnings on net tangible assets (15% x P298,500) Excess annual pre-tax earnings Goodwill (excess earnings capitalized at 25%) P44,000 4,000 P48,000 44,775 P 3,225 P12,900 P82,000 8,000 P74,000 55,275 P18,725 P74,900 Bayer, Inc. P328,500 40,000 P368,500 74,900 P443,400 Lead, Inc. P298,500 P298,500 12,900 P311,400

11-6.

Kris Corporation
(a) This is the first audit of Kris Corporation by Ian and Ronna. Moreover, the company has not been audited by other public accountants during the two previous years of operation. Under these circumstances, the auditors must investigate fully transactions relating to plant and equipment during the two prior years of the companys existence, as well as the records of the year under audit. The adequacy of internal control over plant acquisitions and disposals would be an important part of this review. Since Kris is a relatively new company, this study of prior years transactions can be completed within reasonable time limits. The review of prior years transactions relating to plant and equipment would include analysis of the Repairs and Maintenance expense account and should bring to light the erroneous treatment of plant acquisitions as revenue expenditures during Years 1 and 2. If Ian and Ronna did not investigate the property transactions of the two prior years and the internal controls in force, there would be no satisfactory support for the balances of the property accounts at the end of Year 3, or for the depreciation expense of the year under audit. Remember that one of the auditors basic objectives for plant and equipment is to determine that the property accounts (including the amounts carried forward from prior years) are fairly stated. (b) Both the income statement and the balance sheet prepared at the end of Year 3 would be affected by the errors made in Years 1 and 2. In the balance sheet, the plant and equipment and also the total assets would be understated by the undepreciated cost of the assets which were improperly expensed. Current liabilities and total liabilities would be understated by the additional income taxes applicable to the understatement of prior periods net income due to the accounting errors. The retained earnings and total shareholders equity would be understated by the difference between the understatement of total assets and the understatement of total liabilities. In the Kris income statement, depreciation expense would be understated, income taxes expense overstated, and net income overstated.

11-10. Briggs, Inc. Adjusting Journal Entries - 12/31/06 (1) Organization costs Fixed assets Discount on bonds payable Interest expense Fixed assets Land Fixed assets Organization costs Fixed assets Land Fixed assets Land Fixed assets Interest expense Fixed assets Salaries expense Fixed assets Organization costs Fixed assets Taxes and licenses Fixed assets Building Fixed assets 3,000 3,000 5,650 350 6,000 500,000 500,000 5,000 5,000 4,000 4,000 7,000 7,000 30,000 30,000 50,000 50,000 40,000 40,000 7,000 7,000 2,000,000 2,000,000

(2)

(3)

(4)

(5)

(6)

(7)

(8)

(9)

(10)

(11)

11-11. Aerospace Company Requirement (1) Machinery (cost) Raw materials used Labor Installation cost Materials used in trial runs Factory overhead (incremental) Total Less: Cash discount on materials Net Accumulated depreciation - 12/31/06 (P27,900 x 10% x 4/12) Machine Tools (cost) Less: Amortization for 2006 (4/36 x 2,250) Balance, 12/31/06

P13,600 9,800 1,400 600 2,900 P28,300 400 P27,900

930

P 2,250 250 P 2,000

Requirement (2) Adjusting Journal Entries - 12/31/06 (1) Loss on disposition of machinery Machinery Profit on construction Machinery Machine tools Machinery Machinery Depreciation expense Accumulated depreciation - machinery Purchase discount Machinery Machinery Factory overhead control Tools expense Machine tools 70 70 6,900 6,900 2,250 2,250 3,462 2,532 930 400 400 2,900 2,900 250 250

(2)

(3) (4)

(5)

(6)

(7)

18-1A. Firm A

The financial statements for both firms are found below:

Cash Accounts Receivable Inventories Net Fixed Assets Total Firm B Cash Accounts Receivable Inventories Net Fixed Assets Total

100,000 100,000 300,000 1,500,000 2,000,000

Accounts Payable Notes Payable Bonds Common Equity Total

200,000 200,000 600,000 1,000,000 2,000,000

150,000 50,000 300,000 1,500,000 2,000,000

Accounts Payable Notes Payable Current Liabilities Bonds Common Equity Total

400,000 200,000 600,000 400,000 1,000,000 2,000,000

Financial measures of firm liquidity Firm A 500,000 100,000 1.25 0.5 100,000 Firm B 500,000 (100,000) 0.83 0.33 150,000

Working Capital Net Working Capital Current Ratio Acid Test Ratio Cash

Firm B is obviously the more aggressive of the two firms. Note the fact that it has negative net working capital (current liabilities exceed current assets) and both its current ratio and acid test ratio are lower. Notice that the higher level of cash for Firm B is more than offset by it more aggressive use of current liabilities.

18-15B (a) Days of Sales Outstanding (DSO) = Accounts Receivable Sales/365 Inventories Sales/365 1999 63.6 32.8 2000 62.7 31.5 2001 60.5 26.0

Days of Sales in Inventory (DSI) 1997 59.4 46.9 1998 63.7 24.7

DSO DSI (b)

Days of Payables Outstanding (DPO) =

Accounts Payable Sales/365

Cash Conversion Cycle (CCC) = DSO + DSI - DPO 1997 26.5 79.8 1998 18.9 79.5 1999 20.2 76.2 2000 19.4 74.8 2001 22.6 63.9

DPO CCC

Although there has been some improvement in DSO, DSI, and DPO during the last 5 years, there has been little change during the most recent 2 years. Allergan should focus on collecting receivables faster and increasing inventory turns to reduce the DSO and DSI measures. This will in turn reduce the cash conversion cycle. Allergan should also try to obtain more favorable trade credit terms (i.e. lengthen payment period).

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