Friday, June 3, 2016

Financial accounting An introduction to concepts, methods and uses - Solutions for text book questions with case studies and answers to problems.

Chapter -1 continued

1.40 a. continued.

        (2)   Accrual Basis Accounting
       
               Sales Revenues.......................................................................      $    44,000
               Rent (Office).............................................................................            (2,000)
               Rent (Equipment)..................................................................            (2,000)
               Salaries Expense....................................................................            (6,000)
               Office Supplies Expense........................................................                  (90)
               Interest Expense....................................................................                (133)
               Income (Loss)..........................................................................      $    33,777

b.    Cash on Hand:
            Beginning Balance, July 1......................................................      $              0
        Financing Sources and (Uses):
            Jack Block Share Purchase....................................................           40,000
            Bank Loan..................................................................................            20,000
                 Total Financing Sources.....................................................      $    60,000
        Operating Sources and (Uses):
            Cash Collected from Customers.............................................      $    13,000
            Office Rent..................................................................................            (6,000)
            Equipment Rental....................................................................          (12,000)
            Office Supplies Expense...........................................................                (370)
        Net Operating Uses.......................................................................      $     (5,370)
        Ending Balance, July 31..............................................................      $    54,630

        The ending balance in cash contains the effects of both operating activities, which have net cash flow of $(5,370) and financing activities, which have net cash flow of $60,000.  The firm is financing its operating activities with a bank loan and with funds invested by its owner; both of these sources of funds represent claims on the firm’s assets, not increases in net assets. 
1.41         (Stationery Plus; cash basis versus accrual basis accounting.)

a.    Income for November, 2008:

        (1)   Cash Basis Accounting
       
               Sales..........................................................................................      $    23,000
               Cost of Merchandise..............................................................          (20,000)
               Rent...........................................................................................            (9,000)
               Salaries.....................................................................................          (10,000)
               Utilities.....................................................................................                (480)
               Income (Loss)..........................................................................      $  (16,480)


1.41 a. continued.

        (2)   Accrual Basis Accounting
       
               Sales..........................................................................................      $    56,000
               Cost of Merchandise..............................................................          (29,000)
               Rent...........................................................................................            (1,500)
               Salaries.....................................................................................          (10,000)
               Utilities.....................................................................................                (480)
               Interest.....................................................................................             (1,000)
               Income (Loss)..........................................................................      $    14,020

b.    Income for December, 2008:

        (1)   Cash Basis Accounting
       
               Sales Made in November, Collected in December...........      $    33,000
               Sales Made and Collected in December.............................           34,000
               Cost of Merchandise Acquired in November and Paid
                    in December........................................................................          (20,000)
               Cost of Merchandise Acquired and Paid in December...          (27,500)
               Salaries.....................................................................................          (10,000)
               Utilities.....................................................................................                (480)
               Interest.....................................................................................             (2,000)
               Income (Loss)..........................................................................      $      7,020

        (2)   Accrual Basis Accounting
       
               Sales..........................................................................................      $    62,000
               Cost of Merchandise..............................................................          (33,600)
               Rent...........................................................................................            (1,500)
               Salaries.....................................................................................          (10,000)
               Utilities.....................................................................................                (480)
               Interest.....................................................................................             (1,000)
               Income (Loss)..........................................................................      $    15,420
1.42         (ABC Company; relation between net income and cash flows.)

a.
        January        $     875               $ 1,000                 $     750                  $ 1,125
        February          1,125                   1,000                    1,500                         625
        March                   625                   1,500                    1,875                         250
        April                     250                   2,000                    2,250                             0


1.42 continued.

b.    The cash flow problem arises because of a lag between cash expenditures incurred in producing goods and cash collections from customers once the firm sells those goods.  For example, cash expenditures during February ($1,500) are for goods produced during February and sold during March.  Cash is not collected from customers on these sales, however, until April ($2,000).  A growing firm must generally produce more units than it sells during a period if it is to have sufficient quantities of inventory on hand for future sales.  The cash needed for this higher level of production may well exceed the cash received from the prior period's sales.  Thus, a cash shortage develops.
              The difference between the selling price of goods sold and the cost of those goods equals net income for the period.  As long as selling prices exceed the cost of the goods, a positive net income results.  As the number of units sold increases, net income increases.  A firm does not necessarily recognize revenues and expenses in the same period as the related cash receipts and expenditures.  Thus, cash decreases, even though net income increases.

c.       The income statement and statement of cash flows provide information about the profitability and liquidity, respectively, of a firm during a period.  The fact that net income and cash flows can move in opposite directions highlights the need for information from both statements.  A firm without sufficient cash will not survive, even if it operates profitably.  The balance sheet indicates a firm's asset and equity position at a moment in time.  The deteriorating cash position is evident from the listing of assets at the beginning of each month.  Examining the cash receipts and disbursements during each month, however, identifies the reasons for the deterioration.

d.    Strategies for dealing with the cash flow problem center around (a) reducing the lag between cash outflows to produce widgets and cash inflows from their sale, and (b) increasing the margin between selling prices and production costs.
              To reduce the lag on collection of accounts receivable, ABC might:

       (1)   Provide to customers an incentive to pay faster than 30 days, such as offering a discount if customers pay more quickly or charge interest if customers delay payment.

       (2)   Use the accounts receivable as a basis for external financing, such as borrowing from a bank and using the receivables as collateral or selling (factoring) the receivables for immediate cash.

       (3)   Sell only for cash, although competition may preclude this alternative.
             
              To delay the payment for widgets, ABC might:


1.42 d. continued.
           
(1) Delay paying its suppliers (increases accounts payable) or borrow from a bank using the inventory as collateral (increases bank loan payable).

(2) Reduce the holding period for inventories by instituting a just-in-time inventory system.  This alternative requires ordering raw materials only when needed in production and manufacturing widgets only to customer orders.  Demand appears to be sufficiently predictable so that opportunities for a just-in-time inventory system seem attractive.
             
              To increase the margin between selling price and manufacturing cost, ABC might:

       (1)   Negotiate a lower purchase price with suppliers of raw materials.

       (2)   Substitute more efficient manufacturing equipment for work now done by employees.

       (3)   Increase selling prices.

              The cash flow problem is short-term because it will neutralize itself by June.  This neutralization occurs because the growth rate in sales is declining (500 additional units sold on top of an ever-increasing sales base).  Thus, the firm needs a short-term solution to the cash flow problem.  If the growth rate were steady or increasing, ABC might consider obtaining a more permanent source of cash, such as issuing long-term debt or common stock.
1.43         (Balance sheet and income statement relations.)

a.    Bushels of wheat are the most convenient in this case with the given information.  This question emphasizes the need for a common measuring unit.



1.43 continued.

b.                                                 IVAN AND IGOR
Comparative Balance Sheets
(Amounts in Bushels of Wheat)

                                                IVAN                            IGOR         
                                 Beginning     End of     Beginning     End of
       Assets                  of Period      Period      of Period      Period
Wheat..........................                20              223                     10                105
Fertilizer.....................                  2                 --                         1                   --
Ox.................................                40                 36                     40                  36
Plow.............................                 --                   --                       --                      2
Land............................              100              100                     50                  50
.... Total Assets...........              162              359                   101                193
        Liabilities and
         Owner’s Equity
Accounts Payable.....                 --                    3                      --                    --
Owner’s Equity..........              162              356                   101                193
.... Total Liabilities
.... and Owner’s
.... Equity..................              162              359                   101                193

        Questions will likely arise as to the accounting entity.  One view is that there are two accounting entities (Ivan and Igor) to whom the Red Bearded Baron has entrusted assets and required a periodic reporting on stewardship.  The “owner” in owner’s equity in this case is the Red Bearded Baron.  Another view is that the Red Bearded Baron is the accounting entity, in which case financial statements that combine the financial statements for Ivan and Igor are appropriate.  Identifying the accounting entity depends on the intended use of the financial statements.  For purposes of evaluating the performance of Ivan and Igor, the accounting entities are separate—Ivan and Igor.  To assess the change in wealth of the Red Bearded Baron during the period, the combined financial statements reflect the accounting entity.


1.43 continued.

c.                                                    IVAN AND IGOR
                               Comparative Income Statement
                                (Amounts in Bushels of Wheat)

                                                                                      IVAN       IGOR
            Revenues....................................................................            243             138
            Expenses:
                 Seed.........................................................................               20               10
                 Fertilizer................................................................                 2                 1
                 Depreciation on Ox..............................................                 4                 4
                 Plow.........................................................................                 3                 1
                     Total Expenses.................................................               29               16
            Net Income.................................................................           214            122

        Chapter 1 does not expose students to the concept of depreciation.  Most students, however, grasp the need to record some amount of expense for the ox and the plow.

d.    (Amounts in Bushels of Wheat)                                  IVAN       IGOR
        Owner’s Equity, Beginning of Period.......................            162             101
        Plus Net Income............................................................            214             122
        Less Distributions to Owner.......................................              (20)             (30)
        Owner’s Equity, End of Period ..................................            356            193

e.     We cannot simply compare the amounts of net income for Ivan and Igor because the Red Bearded Baron entrusted them with different amounts of resources.  We must relate the net income amounts to some base.  Several possibilities include:

                                                                                 IVAN         IGOR
        Net Income/Average Total Assets.................................... 82.2%          83.0%
        Net Income/Beginning Total Assets.............................. 132.1%        120.8%
        Net Income/Average Noncurrent Assets...................... 155.1%        137.1%
        Net Income/Beginning Noncurrent Assets.................. 152.9%        135.6%
        Net Income/Average Owner’s Equity ............................. 82.6%          83.0%
        Net Income/Beginning Owner’s Equity........................ 132.1%        120.8%
        Net Income (in bushels)/Acre............................................. 10.70           12.20

        This question has no definitive answer.  Its purpose is to get students to think about performance measurement.  The instructor may or may not wish to devote class time at this point discussing which base is more appropriate.


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